Equity investments in time of volatility

While behavioural finance suggests that greed and fear are the primary factors driving investment decisions of most investors, Warren Buffet believes that discipline is the single most important attributes of successful investors. Greed and fear are natural instincts for most people but discipline has to be practised consciously. Greed and fear is seen mostly in equity investments because equity is a volatile asset class. If you see your investment value drop by 10 – 15%, it is natural to be fearful. You may want to sell your equity assets fearing more losses. But bear market is the worst time to sell your equity assets (stocks or mutual funds) because you will get very low prices. If you have a disciplined approach towards investing, then you will be able to ride out the volatility and create wealth because over a long investment horizon equity is the best performing asset class, giving superior inflation adjusted returns.

Equity as an asset class

Though ideally, we all want prices to go up continuously forever, market cycles are inevitable in investments (across different asset classes). You cannot have bull market forever; bull markets will inevitably be followed by bear markets. However, the history of the stock market in India and in developed as well as emerging economies show that despite economic downturns, recessions, financial crises and bear markets, the long term secular trend of equity as an asset class is upwards. The chart below shows the BSE Sensex growth over the last 30 years. The Sensex has multiplied more than 55 times in the last 30 years, despite market cycles and severe financial crises in the interim.

Source: Bombay Stock Exchange

The chart above shows that equity as an asset class can be extremely volatile due to several risk factors. At the same time it also shows that, equity can create wealth in the long term irrespective of market cycles. However, a disciplined approach is required to ride out the volatility.

Suggested reading: Why is equity the best asset class in the long run

Importance of systematic investments

The three most important attributes of disciplined investing are:-

• Goal based approach


• Long investment horizon


• Investing according to a financial plan

The last point is most important because it addresses the first two points also. Mutual fund systematic investment plan (SIP) is best form of disciplined investing. SIP takes speculation out of the equation in investing because in SIP, there is no price target for investing. You are investing at different price levels through SIP. Since stock markets are intrinsically volatile in nature, you will be investing both at high prices and low prices – this is known as Rupee Cost Averaging.

Every rupee invested by you will earn returns in the long term and the longer you remain invested, you can earn higher returns. Since you can start SIP with small amounts of monthly savings, you can start investing early. Remember, every SIP instalment will help you earn good returns in the future and returns earned on each of your instalments will in turn earn returns (profits themselves). Return on return or profit on profit is known as the power of compounding. The power of compounding in SIP is high because most of your SIP instalments will be remain invested for a long time earning high returns for you.

SIPs in volatile markets

Warren Buffett famously said once that, "only when the tide goes out do you discover who is swimming naked". Everyone is happy and looks good in bull markets, but money made in 2 - 3 years of a bull market can be lost in a few months of a bear market. Your financial plan should work in all market conditions. SIP in good diversified equity mutual funds will ensure that you are never swimming naked either is high tide or low tide. In fact, bear markets are greatly advantageous for disciplined investors in SIP because rupee cost averaging in a bear market will greatly reduce your overall average acquisition cost and in the long term, you can get excellent returns.

How SIP creates wealth for investors across market cycles?

The chart below shows the growth of Rs 10,000 monthly SIP in Nifty 50 TRI over the last 15 years. During this period we had 3 bear market periods, when the index fell more than 20 - 25% (in fact in 2008, the Nifty fell more than 50%). There were numerous other periods when the market corrected 10 – 15%, or remained range-bound for many months. Despite market cycles and volatility, the market value of your SIP started in September 2004 would be over Rs 45.50 lakhs with a cumulative investment of just Rs 18 lakhs (please see the chart below).

Please check - SIP Returns of NIFTY 50 TRI over the last 15 years

Source: Advisorkhoj benchmark returns

Stay put in your SIP in volatile markets

In the previous bear markets, we often saw investors stopping their SIPs and redeeming their investments, but over the last 5 years we have seen a lot of investor maturity, discipline and resilience in volatile markets. It is a very good sign because stopping your SIPs in volatile markets is detrimental to your long term financial interests because you will be unable to take advantage of volatility through SIP. Let us understand this with the help of an example.

Continuing with our previous example of monthly SIP over the last 15 years, let us assume that you stopped your SIP whenever the market corrected by 15% and waited till market recovered.

How long you will you wait? Ideally, every investor would want to invest at the market bottom but timing the market is impossible because multiple bottoms are formed before recovery takes place. Investors usually wait for confidence to return and that can take a year or more. In this example, let us assume you waited for a year to resume your SIP, every time you stopped. The chart below shows your SIP returns with this approach.

Source: Advisorkhoj benchmark returns

You would have accumulated a corpus of Rs 36 lakhs with a cumulative investment of Rs 14.7 lakhs. If you had continued your SIP during volatile markets then with an additional investment of just Rs 3.4 lakhs (over 15 years), you would have increased your wealth by Rs 8 lakhs.

There is no reason to stop your SIPs based on market levels. In fact, the very purpose of SIP is to enable you to invest from your regular savings across different market cycles for your long term financial goals.

Consider increasing your SIP during corrections

Why did just Rs 3.4 lakhs of additional investment (refer to the previous two examples) result in wealth increasing by Rs 8 lakhs (more than 2X the incremental investment)? By continuing your SIP in volatile markets / deep corrections, you buy at very low prices greatly enhancing portfolio returns in the long term. If we extend this logic, then you can consider increasing your SIP in volatile markets by managing your expenses during this period, to create even more wealth in the long term.

Summary

Our advice to investors is to understand the difference between risk and volatility. Risk is the possibility of making a loss. You will make a loss, only if you sell; if you remain invested, chances of making a loss are very low, because the market will eventually recover and set new highs.

Mutual fund SIPs are investment products that help you remain disciplined in your investments and help you benefit from volatility. Instead of worrying about volatility and trying to time the market, you should remain focused on your financial goals and remain disciplined in investing through systematic investment plan.