Mutual Funds Strategy 110: SIP Works Best When Markets Are Falling
Do you know why Systematic Investment Plans perfectly fit investors who do not wish to time the market? The answer is because of Rupee Cost Averaging (RCA).
RCA is obviously borrowed (not stolen) from Dollar Cost Averaging (DCA) and the benefits of them as per Investopedia are:
- Dollar cost averaging can lower the average amount you spend on investments.
- It reinforces the practice of investing regularly to build wealth over time.
- It’s automatic and can take concerns about when to invest out of your hands.
- It removes the pitfalls of market timing, such as buying only when prices have already risen.
- It can ensure that you’re already in the market and ready to buy when events send prices higher.
- It takes emotion out of your investing and prevents you from potentially damaging your portfolio’s returns.
The experts are yet to tell you the disadvantages of investing when the market only goes up. In this article, I will explain that and how to mitigate the risk.
Case 1: When the markets are going up by 1% every month for 3 years. If you are investing 10,000 per month, it will buy you 1000 units when the NAV is at 10.
Next month the NAV goes up by 1%, so it becomes 10.1, so the effective units it would purchase with the same 10000 is 990.099. The next month the NAV would have gone up another 1% and hence the units allotted will reduce to 980.296. By month 36, the units allotted will drop to 705.914 when you invest the same 10000.
The total invested amount = 3,60,000 and the final value of the mutual fund = nav X units = 14.166 X 30408.580 = 4,30,767.94. The absolute return works out to be 19.65%.
My point is that the SIP’s magic is not working here. You would have been better off investing a lumpsum of 360000 at the start and doing nothing for the next 35 months as the final returns would have been = 14.166 X 36000 = 5,09,976 ~ 41.66% absolute returns.
After covid lockdown, Indian stock markets have seen a phenomenal one-sided rally, nothing really could stop this massive f*ing freight train. Nobody realized that their SIPs were buying lower units every other month. When the markets fall, which they usually do — they end up having lower fund value.
As of today, Nifty has already corrected 10% from the all time highs. Let me illustrate the final fund value of the same customer when the markets fall 10%, 15% and 20%.
i) 10% fall: 14.166 NAV will become 12.749 and the new fund value of the customer will be 12.749 x 30408.58 = 3,87,678.98 thereby reducing her 3-year absolute average to just 7.68%.
ii) 15% fall: 14.166 NAV will become 12.041 and the new fund value of the customer will be 12.041 x 30408.58 = 3,66,149.71 thereby reducing her 3-year absolute average to just 1.708%.
iii) 20% fall: 14.166 NAV will become 11.332 and the new fund value of the customer will be 11.332 x 30408.58 = 3,44,590.02 thereby reducing her 3-year absolute average to -4.2% (negative returns).
For SIP to work its magic of Rupee Cost Averaging (RCA), the markets have to dip when you start to invest and it should recover and close higher when you are nearing the redemption. Only then you will get more bang for your buck. In other words, the best time to do an SIP is in a falling market and not in a rising market.
Case 2: When markets are falling 1% every month for 3 years. Your 10000 investment per month will fetch you 43156.98 units in 36 months with a final fund value = 7.034 X 43156.98 = 3,03,566.197. That also means you have an unrealized loss of 56,433 at an absolute return of -15.67% (negative).
Had you done a lumpsum, your fund value would have been 2,53,224. A loss of 1,06,776 ~ -29.66% (negative). SIPs actually helped you narrow the losses.
If the markets recover and go up, you stand to make a killing as the sum of units = 43156.98.
i) 10% upmove, means your fund value will be: 3,33,922.81.
ii) 15% upmove, fund value = 3,49,101.12.
iii) 20% upmove, fund value = 3,64,279.43 (recovered the cost).
iv) 25% upmove, fund value = 3,79,457.74
Case 3: Normal market conditions:
Markets usually follow a zig-zag pattern rather than a uni-directional movement, so the ideal case would be something in between case 1 and case 2.
You are free to try out the combinations on this spreadsheet, click here.
Do let me know in the comments section, what data points you were looking at and how it surprised you.
I request you to try out the different possibilities and combinations, in case you require help — you can reach out to me @viswaram
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Calculators are for illustrations only and do not represent actual returns.
Mutual Fund investments are subject to market risks; read all scheme-related documents carefully.