Winning Strategy for a Volatile Market
Andrew L D'Cunha
Oct 10, 2011
"Market is crashing..shall I stop my Systematic Investment Plan?"
"Shall I redeem the funds invested in mutual funds?"
These are the common questions from the scared investors during market fall. Equities are nose-diving and investors are scared. From its 52-week intraday high of 21,109 points in November last year, the BSE Sensex, closed at low of 16,233 on Friday October 7th 2011., down by 23%. Financial markets all over the world are witnessing see-saw volatility. The wild swings in the market are eroding the confidence of investors. Many investors are tempted to sell everything and pull out of the market, accepting their losses. The truth is that most people ignore the most important factor in an investment – risk.
Stock market is a roller coaster that will take you upside and even downside. Investment markets move in cycles and it’s difficult to forecast when they’ll rise or fall. It's normal to be nervous when market is crashing. Investors should understand that when "bull market" sentiments drives the market to the heights in excess of what economic fundamentals warrants and market starts correcting itself to the level that can be justified on expectations of growth, sustainability and rates of return. Getting prepared well in advance will make you calm, steady and of course a winner. If you are 35 and investing for your retirement plan or for your 5 year old child’s higher education, brief market downturn should not derail your investment plan.
Why Equity investment?
Equities are a very simple asset class. Though due to market swings in short term equities can give negative returns, over a long run equities has consistently outperformed all the asset classes and generated wealth for the investors.. Investing in India stock market is like investing in the businesses of fast growing Indian economy. Every other asset class depends on money generated from companies (businesses). Businesses in India have grown at 15%-plus compounded annual growth rate (CAGR) and that’s why the Sensex has delivered 18-20% CAGR.. Economic growth prospects of India is very bright. Indian is second fastest growing economy in the world behind China. India should become one of the top five economies of the world in 5-10 years. India’s sustained economic growth, entrepreneurial society and young population have it poised to become an economic superpower within the next 15 years.
The more we understand the markets historical returns and volatility the better the investment decisions we are likely to make. The BSE index started on 31 March 1979 at 100 points and on 31/3/2011 closed at 19445 points. Yearly growth of 15-20% including dividend yield. During these 30 years time market has seen wars, natural calamities, scams, scandals, government change, terror strikes. If we look at the last ten years, the Sensex has given returns of about 18% compounded, which is from 2001 to 2011 and additional 1% to 2% of dividend yield i.e. about 20%. Of course, investors should also understand that fast performance is no guarantee of future results. Over the last five years, we have seen this market go to 16,000, fall to 12,000 or below 10,000 then go up all the way to 21,000, major slump to 8,000, and back to 21,000 followed by another fall to 16000.
Investing is like driving to reach a particular destination. Investors cannot reach the goal if they terminate their planned long distance journey, if they panic looking at the rough patches, potholes, ups and downs and blind turns and even bad drivers. Yes, investors have to be more cautious, but have to keep on going to reach our final destination. Long term financial journey is not smooth. They will encounter market volatility several times, along the way. We are on an economically bumpy road full of hurdles and shocks of various kinds such as liquidity, monetary, political, inflation, exchange rate, scams etc are disturbing the system.
"If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the "hamburgers" they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices" Warren Buffet in his 1997 letter to Berkshire Hathaway shareholders .
Since no one can predict how the markets will perform, it’s important to develop an investment strategy that can help you stay on the right track to meeting your long-term financial goals. Investment should be less emotional more methodical. Systematic Investment Plan is a fantastic way to even out volatility.
Power of Systematic Investment Plan
Investors can build wealth for long term if they consider volatility as their friend and make that friend work for you. Volatility really works to the advantage of somebody who is doing an SIP because he is able to capture several of these volatile movements in the markets place. He may not be able to do on his own, but a well managed mutual fund is able to do so because they are able to get the money and since the mandate is to be invested at all points of time, they go and invest on your behalf.
Growth from the investment can’t usually be achieved without exposing your investment some risk – being too cautious can also put your investment at risk. So getting the balance right is a key challenge to meeting your own investment objective. SIP is a tool which makes sure that what you save is what you invest. By investing you are participating in Indian growth story. India is on a solid growth path and volatility will remain given a political setup, dependence on the global economy and foreign flows, interest rate, inflation and the kind of changes that we keep seeing in our policy regime. India will remain a volatile market and SIP is one of the best ways to move forward. In volatile market when downturn is hard to predict, regular monthly investment can
• Provide smoother return
• Ensure you buy more units when market price is lower and few units when market price is higher, lowering the average price paid per units. Doing this enables you to take advantage of declines, while reducing your chance of making large financial commitments at the market's peak. Over the long term it may help you reduce the average cost you pay for units a level below the average price SIP best works to achieve your medium and long term goals; it may be building corpus for child’s education and child’s marriage , planning for retirement, planning for home etc.
Current volatility is an opportunity to enhance their SIPs, rather than stop or lower them. For an SIP to deliver the good returns, it must witness a falling market. This way the investor can average out his cost of purchase. If the investor does not witness a downturn, i.e. he is only exposed to a market rally, the average purchase cost of his SIP will rise over a period of time. SIP’s are meant to eliminate market time. But investors must opt for a long enough SIP’ tenure so as to "time" the market downturn. It's not timing the market that will earn you the greatest reward. It's your time in the market that will create wealth.
High investment returns cannot be earned without taking substantial risk. Safe investments produce low returns The market crash of 2008 ended up as a great way of improving returns. What looked like the end of the financial world at one point actually delivered great returns for those who kept the faith and continued their SIPs throughout the low period.
Here is an example of Diversified mutual fund, its performance during market fall in 2008 and market recovery in 2009.
• Chart A: If Investor started his Systematic Investment Plan on 01.01.08 when Sensex was at peak above 20000 level with monthly investment of Rs. 10000 and terminates his SIP on 01.04.09.
Points to be noted from above data:
• Investor started his SIP on 01.01.08 when Sensex was at peak above 20000 level. Monthly investment Rs. 10000 and terminates his SIP on 01.04.09.
• Investor received less units 44.53 units at a rate of 224.59 on 01.01.08 when market is high.
• Investor received more units 103.92 units at a rate of 96.23 on 02.03.09 when market is low (Sensex at 8607).
• As of 01.04.09 investor accumulated 1164.55 units at an average rate of 146.51.
• As of 01.04.09 invested amount is Rs. 1,60,000/- and value of 1164.55 units at rate of 110.15 is only Rs. 128.125. If investor stopped his SIP investment and sold his units in panic he would have made a loss of Rs.31,875/-. Yearly return is minus 31.32%
• As of 01.12.09 value of 1164.55 units at rate of 227.75 is Rs. 265,226. Gain of Rs. 1,05,226/-
• As of 01.12.10 value of 1164.55 units at rate of 302.13 is Rs. 351,845. Gain of Rs. 1,91,845/-
• The point of maximum uncertainty is also equal to the point of maximum return. The value of 103.92 units purchased for Rs. 10000 on 02.03.09 as of 01.12.10 at rate of 302.13 is Rs 31,397 !
• Chart B: If Investor started his Systematic Investment Plan on 01.01.08 when Sensex was at peak above 20000 level with monthly investment Rs. 10000 and continued his SIP till December 2010.
• As of 01.12.10 investor accumulated 2070.46 units at an average rate of 193.11
• As of 01.12.10 value of 2070.46 units at rate of 302.13 is y Rs. 625,548. Invested amount Rs 3,60,000. Gain of Rs. 2,65,548/-. Return on Investment (Yearly) 41.66%
• A good mutual fund can outperform Sensex by large margin. On 01.01.2008 when Sensex was at 20300 NAV of this fund was 224,59. On 01.11.2010 when Sensex was at 20356 NAV of this fund was 306.97.
Investors get more units for the same amount of money in falling markets. The units bought at lower price-levels will appreciate when the market turns around, adding to the overall portfolio value. SIPs have the potential to minimize losses and generate returns.
I have not given name of the fund here as being unbiased financial advisor I don’t want to endorse any product in web portal. The example is given only to make readers understand the power of Systematic Investment Plan in volatile market. Readers also note that mutual fund investments are subject to market risks. Mutual funds are not guaranteed return products. Past performance may or may not be sustained in future.
Long term SIP return of Diversified Multi Cap fund
Rs 10000/- per month in this scheme for last 14 years, it is worth Rs 1.85 crores with annualized return of 30.8%.
I have not given name of the fund here as being independent financial advisor I don’t want to endorse any product on web portal. The example is given only to make readers understand the power of Systematic Investment Plan in volatile market. Readers also note that mutual fund investments are subject to market risks. Mutual funds are not guaranteed return products. Past performance may or may not be sustained in future.
Though the above SIP returns look very attractive, investor need to know that the journey would have been bumpy during the above period. Only long term investor with clear goal in mind can secure this return.
The right approach during all kinds of markets is to be realistic. Investors need to have a plan to reach their financial goal striking a right balance between risk and return. When market reaches to a particular point investors can reduce the risk of their portfolio by switching a part of funds to from equity to debt depending upon their risk tolerance.
Preparation, patience and discipline are important aspects of investment. Don’t allow your long term plans to get crushed by the market sentiments. Through SIP reduce your exposure to risk without reducing your exposure to equity. Be a winner by turning market volatility to your favour. Stock market is like sea which is forever changing. Sometimes calm, peaceful and sometimes chaotic with huge and violent waves. Surfers should adopt a strategy to ride these waves over and over again. Systematic Investment Plan is the best strategy to ride the market waves.