One of the most common questions investors had during the COVID crisis was what they must do with their ongoing SIPs (Systematic Investment Plan)? Although this tool of investing has been around for nearly two decades now, investors continue to remain wary about its efficacy in different market scenarios. With this in mind, I have penned down four simple tips which I am sure will clear any doubts you have.
The shorter the SIP investment period, the greater the probability of losses
Value Research published a study on the performance of the SIP investment made in diversified equity mutual funds. It revealed that SIPs for :
one year had a 22.5% chance of making a loss
two-year had a 16.2 % chance
five-year had a 3.3% chance
ten-year had a 0.3% chance
Inferring that as your investment period increases, your probability of making a loss in the SIP method of investing reduces. But why does this happen?
History tells us that a bear market in India lasts for around 1-3 years max. So if you enter the markets at the beginning of a bear phase, by the end of Year3, your investment returns will turn positive.
Furthermore, a bear market is the best time for any investments, especially SIPs in mutual funds. In a bear market, you are effectively buying more units of the mutual fund for the same amount of money. So, if you are in a bear market again, the trick is not to panic and continue with your SIPs.
If you catch a market peak, extend your investment time horizon
The SIP method of investing eliminates the need for timing the markets. It's one of it's most attractive features as this helps you average out of the cost of investment. It allows you to invest at both the high and the low points of the market.
So, if you invest at the worst possible time, a market peak, your probability of a loss is high. At a time like this, continue with your SIPs i.e., extend your investment horizon. And then, when the markets eventually begin their descent, your investment costs will also fall.
So, the key here is to also continue with your SIP investments. It will help you average your costs as the market recedes from peaks.
A good time to pause or stop your SIP
Investments are meant to reduce your stress. You are putting away money for a better tomorrow or even preparing for a large future outgo. But there is a good chance the same might have not held in the past few months.
The COVID crisis led to massive unrest on multiple levels. In addition to the health crisis, the world had to undergo an economic crisis. People lost their jobs or had to shut their line of work, leaving them without any primary source of income. These uncertain times highlighted the need for an emergency fund, a few months worth of living expenses stashed away in a safe and accessible asset.
And so, if you didn't have an adequate emergency fund, this was the time to make up for it. Perhaps the only time to stop or pause your ongoing SIPs to ensure your emergency fund is stacked up.
The idea is to ensure that before you move any money to investments, you must have an adequate emergency fund. So you can look after yourself and your family in challenging times.
SIPs can't turn a poorly performing fund into a good one
No matter how persistent you are with your investments or how lucky you are with the timing, SIPs can't turn a poorly performing fund around. So if your portfolio is underperforming, don't blame the SIP method of investing. Analyse your fund instead, comparing its returns with the relevant peers and benchmark indices.
Investing in a bad fund can only lead to mounting losses (in the form of opportunity cost). Hence you must monitor the performance of your funds periodically. Avoid judging them based on their near term performance. The key is to invest in funds that have consistently outperformed their peers and benchmark indices.
SIPs are a great investment tool, but only if you allow them to be. Panicking when the markets fall or failing to maintain an adequate emergency fund can easily derail the best laid plans, forcing you to stop or pause your SIPs. Investments in the stock markets need time to realise their full potential. So the key is to prepare yourself well enough, emotionally and financially, to do so.