Why stopping mutual fund SIPs when stock market falls can jeopardise your financial goals
- Volatility is inherent to equities. It is practically impossible to predict how markets will behave on a certain day.
- Equities are not a good choice if your goal is very near. Financial planners say the tenure of the investment is critical.
- Few realise that if their goals are very long-term, a fall in the market today is actually an opportunity to buy more at lower prices.
The 806-point drop in the Sensex on 4 October was the fifth biggest single day loss registered by the BSE benchmark in the past five years. In Mumbai, newbie investor Rashmi Rajagopal is feeling jittery about her portfolio of equity funds. She started investing in equity funds about a year ago. “My portfolio grew handsomely till last month, but is now in the red. Frankly, I don’t know whether I should stop my SIPs, withdraw my money or continue investing,” says the 44-year-old marketing manager.
Market timing is a myth
Volatility is inherent to equities. It is practically impossible to predict how markets will behave on a certain day. ET Wealth back-tested to see whether mutual fund investors should try to time the market by getting out before they crash. An investor who started SIPs in a diversified equity fund five years ago and continued investing irrespective of market movements would have earned a return of 10.5%. But an investor who managed to avoid the 10 biggest falls in the Sensex by getting out a day before the crash would have earned 13.8% returns.
10 biggest falls in the Sensex since 2013
The 806-point crash on 4 October was the fifth biggest single-day loss in % terms for the Sensex in the past five years
The findings of the study suggest that timing the market can yield good profits. But the study has assumed that Perfect Timer was able to correctly predict all the 10 market crashes. Besides the impeccable clairvoyance, he also had the guts to reinvest the entire redemption amount on the next SIP date. “He is an absolute Nostradamus. We should hire him as a fund manager,” jokes the CEO of a large mutual fund house.
In the real world, one doesn’t get it right all the time. Even if Perfect Timer missed one of the crashes, some of the gains would have been shaved off from the overall returns. Also, an investor who got jittery by a 2-3% fall in the index would probably not reinvest in a hurry. Cautious Timer is assumed to have skipped one SIP after the crash before he gathered courage to re-enter the market. He reinvested the redeemed amount along with the missed SIP on the following SIP date. Not surprisingly, he did not make more than what Regular Investor earned by simply continuing his SIPs over the five-year tenure.
Should you be bullish?
Few realise that if their goals are very longterm, a fall in the market today is actually an opportunity to buy more at lower prices. By that logic, people should be rushing to invest every time markets plunge. “My goals are 15-20 years away so these short-term dips don’t bother me much. In fact, I see market crashes as opportunities and put in lump sums to supplement my SIPs when markets are down,” says Pune-based Amol Mahulikar. The 41-year-old IT professional is saving for his kids’ higher education and his own retirement.
This makes obvious sense, but it is best not to tinker with your ongoing SIPs. The Bullish Timer in our study invested more on the day of the crash by advancing the next month’s SIP. He makes marginally more than the Regular SIP investor.
Should SIP investors try to time the market?
When markets tumble, investors stop their SIPs or redeem their funds. We back-tested to see how much an SIP investor would have made by avoiding the 10 biggest falls in the Sensex since October 2013.
i. Regular investor: Kept investing through SIPs irrespective of market movements
Easiest strategy to follow : Requires no effort on the part of the investor. He just needs to keep investing in a disciplined manner.
Corpus value: Rs 3.96 Lakh
Needs to be lucky all the time: Must have clairvoyance to predict market movements and courage to reinvest entire sum on next SIP date.
Corpus value: Rs 4.33 Lakh (Less Rs 5,945 tax on short term capital gains.)
iii. Cautious timer: Exited a day before all 10 crashes but reinvested after skipping next month’s SIP.
Most people likely to follow this strategy: Must have the same clairvoyance as Perfect Timer, as also the stomach to reinvest after a gap of a month.
Corpus value:Rs 3.96 Lakh (Plus Rs 4,151 short-term capital loss which can be adjusted against other gains)
iv. Bullish timer: Invested more on all 10 crashes by advancing the next month’s SIP
Sounds good on paper but difficult to follow: Must be able to invest on a day when everything is falling apart. Even this courage will not yield big returns.
Corpus value:Rs 3.97 Lakh
All investors started SIPs of Rs 5,000 in a diversified equity fund (HDFC Equity) in October 2013. All SIPs assumed to be made on the first trading day of every month. Returns calculated on the basis of IRR. Data as on 4 Oct 2018.
Investment horizon is key
It is often said that when it comes to long term investing, no other asset class can match the potential of equities. At the same time, equities are not a good choice if your goal is very near. Financial planners say the tenure of the investment is critical. “Investors with short-term goals (1-2 years away) should stay clear of equity-oriented instruments as they are risky,” says Deepti Goel, Associate Partner, Alpha Capital.
But if the goal is more than 8-10 years away, one should avoid fixed income investments because they will not be able to match the returns offered by equities. Stock market corrections should not push investors away from equities. We sought recommendations for four fund investors in different situations from a mutual fund expert.
WHAT SHOULD FUND INVESTORS DO?
The time horizon of financial goals should guide the decision of mutual fund investors. A mutual fund expert (TheMFGuy ) tells investors in different situations what they should do now.
Risk profile: Moderately aggressive
Goals are more than 8-10 years away.
• Investing in diversified equity funds for more than 10 years.
• SIPs continuing in these funds.
• Built up a large corpus for financial goals.
What he should do: His goals are still quite far away. Though his corpus might witness some swing due to volatility, he should not panic but continue SIPs in a disciplined way. In fact, he should invest more with every 5% correction, especially in mid- and small-cap funds that have corrected sharply in past 5-6 months. But exposure to equities should not exceed 60-70% of total portfolio.
Risk profile: Risk averse
Major financial goals are 2-3 years away
• Investing in equity and hybrid mutual funds for past 5-6 years.
• Has got good returns till now but worried by downturn.
• Some SIPs still running in equity funds
What he should do: As goals come nearer, one should gradually reduce equity exposure to reduce the risk of volatility. Given that goals are just three years away, he should start booking profi ts gradually and shift from equity to debt. SIPs can be stopped and a monthly STP started from equity funds to debt funds. The equity exposure should be restricted to 40% of the portfolio.
Risk profile: Low risk
Financial goals are more than 15-20 years away
• Started investing in equity mutual funds last year.
• Has SIPs running in mix of large- mid- and small-cap funds.
• Earned good returns initially but now feeling nervous.
What he should do: The key ingredients for success in investing are patience, discipline and the ability to stomach volatility. Investors stop SIPs when markets are volatile and restart when markets are doing well. But SIPs work best when markets are falling. Investors who continued SIPs during 2008-2009 and 2011-2013 when markets were weak, made more money than those who invested only when markets were doing well. Since the goals are long term, do not panic but continue SIPs.
Risk profile: Very aggressive
Financial goals are mix of short-, medium and long-term target
• Investing in equity funds since she started working 1-2 years ago
• SIPs running in ELSS, multi-cap and mid-cap funds.
• Returns are down but she is bullish.
What she should do : Young investors like her can take a more aggressive stance in their investments. At the same time, she should keep enough liquidity for meeting her short-term goals by investing in debt funds as well. This will ensure that she will not need to dip into her equity investments and can enjoy the benefi ts of compounding over the long term.
(TheMFGuy is a CA who blogs on mutual funds and personal finance on themfguy.wordpress.com)
In all cases, equity funds were recommended for long-term goals. However, while equities have the potential to create wealth for investors, poorly chosen stocks can also destroy wealth. Some stocks have destroyed huge amounts of investor wealth.
Stocks that are biggest wealth destroyers
Rs 5 lakh invested in these stocks 10 years ago is now worth Rs 29,517
Obscure stocks destroyed more wealth
Rs 5 lakh invested in these stocks 10 years ago is now worth Rs 1,144
Many of the wealth destroyers (Unitech, JP Associates, Suzlon) were once considered bluechip stocks and even figured in the benchmark indices. Stocks of smaller and little known companies have fared even worse—Rs 1 lakh invested in some of these companies 10 years ago is now worth Rs 100-200.
Dump the underperformers
To a certain extent, investors in mutual funds are insulated from such toxic investments. Investment teams spend days poring over annual reports and balance sheets before they give the green signal to include a stock in a fund’s portfolio. A fund manager will eject a stock from the portfolio if there is the slightest hint of mismanagement or the company has poor prospects.
Investor wealth idling in underperformers
Get rid of chronic underperformers if they do badly for more than four quarters
Even so, some funds are not able to get it right and tend to underperform. This happens if the fund manager is not paying enough attention to the scheme’s portfolio or is just plain unlucky in his investment calls. Either way, the investor stands to lose. We looked up the returns of equity funds and found that 33 schemes had consistently lagged their benchmarks in the past one year, three-year and five-year periods. An estimated Rs 18,000 crore of investor wealth is languishing in underperforming schemes. Investors should get out of these funds and shift to better managed schemes.
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