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Adjust The Sail To Sway The Wind

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Adjust The Sail To Sway The Wind
Devangshu Datta - 11 February 2020

According to International Monetary Fund’s latest advisories, India is experiencing an economic slowdown serious enough to affect global growth.

Does this mean your investment returns can go down and equity returns in particular, could be in the negative? Yes. That’s the fact.  But, does that mean you should stop investing in equity? Well, the answer is no!

To understand why it is important to keep investing in equity, we need to know how it works. Equity prices are volatile in the short-term. In any given year, stocks might lose or gain a lot. But in the long-term, the volatility smoothens out; over a very long term, returns from equity, outrun debt, real estate and even precious metals.

Every serious investor must have an equity component in his or her portfolio. Best results come when investors hold for at least three years and preferably longer. This is lesson number one for any equity investor.

The second point is that volatility is also smoothened out by buying small amounts at different prices rather than investing in single chunks. Equity sway with time. Anyone who buys at different prices gets an averaged price. If you buy one big chunk at one given price, you may or may not get lucky. That is lesson number two: small investments, spread over different prices and time perform better than bigger ones made at one shot.

The third point is that it is very difficult to predict likely returns from any one business. If you hold one stock, and it becomes a big success, the returns could multiply. However, if that one business folds up, you could lose all your money. Hence, you run a risk.

If you spread investments across multiple businesses, you will have some successes and some failures. However, the overall return is likely to be positive. Moreover, your chances of success will further improve even if you put together a portfolio from different sectors. That is because different businesses do well at different points of time. Therefore, it is always better to create your own portfolio.

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To cite an obvious example, the aviation industry’s costs vary according to fuel prices. Fuel prices are low when crude prices are low. So, the aviation industry performs well when the oil and gas production industry is doing badly. If you consider analysing both the industries, you will see one of them is usually performing well. This effect is seen across many sectors. That is lesson number three: diversified portfolios yield more predictable returns than highly-concentrated ones.

Putting these three lessons or points together, one can draw a logical conclusion that—diversified equity funds yield predictable and good returns, provided, not only Systematic Investment Plans (SIP) are used to invest but also continued in the long-term.

Studies indicate that SIPs generally give better returns than “chunk investing” in the same funds. SIPs are also more convenient because most people find it easier to put aside small amount of money on a monthly basis, rather than making single large commitments.

Aggregated mutual fund data suggests that SIPs scored about 0.5 per cent more than “chunk” returns over the last ten years. It means that an investor, who bought a mutual fund in January 2010, would score about 0.5 per cent less compounded to an investor who bought a 10-year-SIP, brought through every month.

In the past three years, fund investors have realised the benefits of SIPs. In 2016, the average monthly commitment to SIPs was Rs2000 crore, which has now gone up to about Rs8000 crore. However, most investors generally tend to overlook the time factor and commit to SIPs for only one or two years, when it should be at least three years, or more.

Often investors commit the mistake of getting swayed by current returns. Analysis of SIP inflows and outflows indicate, investors make more clinkers during bull run and less during the bearish periods.This is a rather poor strategy. Systematic investment plans work best when average prices are low, rather than when they are high.

So there you have it—the economy is in a slowdown; stock markets could nose dive anytime. However, ignore these episodes and continue with SIP investments across diversified equity funds. If the market at all dips, consider increasing the SIP commitments.  

 

The author tracks economic, behavioural and corporate trends, hoping to gauge good avenues of returns

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