The stock market has been highly volatile this year. There was a big fall in the market after the Budget and over the last month or so we are again seeing a sell-off due to Indian Rupee depreciation. In the interim period from April to August 2018, the market recovered from the post Budget low and made an all-time high. Investors are often tempted to book profits or exit from equities when markets are high.
Valuations in high markets and effect on returns
When the market makes all time highs, valuations often get stretched. When Nifty made its all time high in August, its P/E ratio was 28.7, which was well above the historical average. Even after a 12% fall in Nifty over the past month or so the market is still expensive (P/E ratio of 25) compared to the historical average valuations. Investors may feel jittery to invest at high valuations. However, if we go back three years to October 2015, the Nifty P/E ratio was 22 – 23, which was again in the expensive zone. Nifty 50 has given total return of 38% over the last 3 years. Even when the market was high or expensive, Nifty gave annualized return of more than 11%, which is much higher than fixed income (bank FD) post tax returns. This shows that market level is not a very important factor for long term investors; the most important factor for long term investors in the investment tenor.
Investing through mutual fund SIP in high markets
Some people say that it is unwise to invest through mutual fund Systematic Investment Plans in high market because you are buying mutual fund units at higher and higher cost. They point out to the fact that some equity mutual funds have given negative SIP returns in the last 3 years. However, if we dig slightly deeper, we will see that the mutual funds which gave negative SIP returns were primarily small cap mutual funds. We had an unusual situation with the small cap segment of the market over the last 3 years – the valuations of small cap stocks were extraordinarily high, much higher than the large cap and naturally a big correction was overdue. If we look at the large cap category of mutual funds, the top quartile large cap funds gave over 8-9%+ SIP returns in the last 5 years, higher than FD returns, despite the market sell-off over the past month or so.
While there is no denying that average mutual fund SIP return in the last 3 years was low relative to what retail investors in India normally expect, investors should also remember that 3 years is not a sufficiently long investment horizon for SIP to realize its potential. SIP should be linked to our long term financial goals like retirement planning children’s education etc. In short tenors (3 years or less) SIP returns can be low, depending on market conditions, but over sufficiently long investment horizon mutual fund SIPs have created substantial wealth for investors in the past.
Can you get better returns by timing the market?
Let us assume you started your monthly SIP of Rs 10,000 in Nifty 10 years back. In an attempt to time the market, you stopped your SIP every time the market rose 20%, booked profits by redeeming all your units and parked your redemption proceeds in a fixed deposit paying an interest rate of 8%. Then you waited the market to correct 10% from its high to resume the SIP. When you resume your SIP, you also re-invested the redemption proceeds along with the missed SIP instalments, which we assume were invested in a recurring deposit account (paying 8%) for the time the SIP was stopped.
Before we go further with this analysis, let us caveat these assumptions with our practical experience. It is difficult to remain disciplined when you are trying to time the market because greed (in bull market) and fear (in bear market) overrules discipline. But for the sake of argument, let us assume that you were able to exit and enter at specified percentage rise or falls. For the sake of simplicity, let us ignore mutual fund exit loads and premature FD withdrawal charges. Let us now see how much corpus you would have accumulated. With a cumulative investment of Rs 12 Lakhs, you would have accumulated a corpus of Rs 20.6 Lakhs. You would have exited and re-entered 5 times in the last 10 years.
Let us now take another scenario, where you kept investing in Nifty through SIP (of Rs 10,000 per month) in a disciplined manner for the last 10 years completely ignoring market levels. You would have accumulated a corpus of Rs 20.2 Lakhs (see the chart below).
For all the effort you would have put in timing the market, you would not have gained anything substantially material over what you have got by simply continuing your mutual fund SIPs irrespective of market level. This shows the futility of trying to time the market if you are a long term investor.
Conclusion
- Market timing is irrelevant in mutual fund SIPs for long term investors. The benefits of Rupee Cost Averaging over a long investment tenor covering several market cycles, negates advantages investors might try to gain by timing.
- Trying to time the market may harm your long term financial objectives because getting an attractive entry after exit can be difficult in a growth market like India.
- Power of compounding unlocks the real value of SIP mode of investment in mutual funds over a long investment horizon. History of stock market over the last 100 years tells us that the market keeps on making new highs, irrespective of bear markets in the interim. The longer you remain invested greater is power of compounding and your returns.
- Mutual fund SIP is the best way of investing in a disciplined manner for your long term financial goals. You should continue to invest irrespective of market levels till your financial goal is achieved.
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