For all those who are fretting about the Coronavirus, remember that the stock markets have bounced back after each epidemic. There is no reason why the markets will not bounce back after the latest virus. But investors have a more practical question; should they invest lump sum or stick to SIPs after this correction? Let us first understand what a SIP is all about?
What exactly is a SIP?
A systematic investment plan (SIP) is a gradual wealth building approach by investing in a mutual fund (typically an equity fund). The benefits are more pronounced in an equity fund than in a debt fund or a liquid fund. The SIP entails regular investment of a fixed sum of money in an equity fund on a fixed date. SIPs can be weekly, monthly or quarterly but monthly SIPs are the most popular. You can select the date and each month on the SIP date, the number of units gets allocated to you against the amount debited. The advantage is that when markets go up you get more value and when markets go down you get more units. As a result, over a longer period of time (6-8 years) the average cost is lower and the returns are higher. In popular parlance, this is called rupee cost averaging and generally works in favour of the investor. But what is the best time to start a SIP?
Can you start a SIP at any point of time?
Before we answer that question, you need to be clear about the purpose of the SIP. If you are starting a SIP for a long term goal like retirement or your daughter’s college education, then you are talking of a goal that is typically 15-20 years away. Here, the timing of the SIP will not be too important as the longer time period will ensure that anomalies are smoothed out. For example, if you had started an equity fund SIP in 2001, it would not have mattered whether you started the SIP at a Sensex level of 3300 or at 2800 because the Sensex is more than 10 times that level today. The difference would be negligible. For your long term goals, you don’t have to exert over the timing of the SIP.
For shorter tenure SIPs – It is better to start high than to start low
When do you start a SIP if your holding period is 3-5 years? What is a better time to start a SIP, when the market is at the peak or when the market is at a bottom? Clearly, the market top is a better time to start a SIP because you know that with each lower level in the market, you would be accumulating units at lower levels. By the time the market completes the fall, you would have managed to accumulate your SIP at attractive levels. On the other hand if you start a SIP at the bottom, each subsequent purchase will be at a higher price. If it is a secular market bounce, then it may not be an issue. However, if the market becomes flat or volatile after that, then a SIP may not yield results. When the market has corrected sharply, as is the case after the Nifty has corrected 35% from the peak, lump sum investing is a better idea. You have a better chance of riding the rally if you buy lump sum.
What if my SIP is already running and markets have crashed?
A slightly more complicated situation would be if your SIP is already running. Should you stop the SIP and invest lump sum? If you have been running the SIP, you would have already made the best of the market correction. Hence, you don’t need to worry too much about stopping the SIP. That becomes too much of a timing call which goes against the basic grain of SIPs. When you stop a SIP, you can leave the existing investment as it is but then you are also terminating the SIP discipline. If you sell out there is a profit / loss you need to book and it has implications in terms of transaction costs and taxes.
When the markets correct, you can look at some strategic buying in high quality stocks or funds at lower levels, if you have a surplus with you. It is true that lump sum investment do better from the bottom of a market but it may not really be practical. A better idea is to persist with your SIP.