There is a strong belief in the personal finance domain in India – that Systematic Investment Plans (SIPs) are the best. The unstated corollary of this belief is that market timing is bad. The unexpected fallout is that emerging affluent investors are afraid of making one-time investments in equity markets and mutual funds.
Overdoing the SIP logic can be bad for an investor’s portfolio because it may keep her significantly under-invested in equities. We explore the dynamics of this phenomenon below.
Systematic investing works well for monthly savings
First things first, SIPs serve a large majority of the population well – especially those new to capital markets. As it happens, many of these are salaried individuals who have savings generated every month, typically at the start. SIPs help invest these savings without giving the earning person a chance to squander them away on some superfluous purchase. Many households think of them as being as strict as EMIs, although they are not.
This arrangement works well to cover the behavioural quirks of human beings. We do not like making active decisions. If there is money lying idle in the bank account and one needs to make an investment, which is an active decision. However, if the SIP is going to happen automatically on the fifth of every month and one needs to stop it through some effort for it avoid the investment, such stopping is still an active decision. For a disciplined investment program, SIPs work well!
Lump-sum investments hit a snag in the SIP approach
Now let us come to the subset of investors that make occasional lump-sum investments. This can be on account of annual bonus or sale of a property or redemption of tax-free bonds. Investors that are used to SIPs tend to get nervous about investing a larger sum in one go – in mutual funds or stocks. This is because of two factors. First, it is an active decision (which we saw above is behaviourally difficult for human beings) and second, markets are volatile, and investors always wonder if it is a good time to invest.
On the second question, SIP over-reliance makes things very difficult. To convince investors that SIPs are good, mutual funds and financial advisors keep drilling into investors’ heads that market timing is bad, and that you should simply invest through SIPs. This logic stops working for lump-sum investments. Many investors mentally map SIPs with monthly savings. The one-time inflow just does not fit into that system for them. They are left without a coherent approach for one-time investments.
The bad choices for one-time investments
This problem is compounded by ‘push’ products hawked by several banks and wealth management firms, not to mention the new fund offerings of mutual funds. As advisors realise that investors have spare money, they bombard the investor with all sorts of product ideas – NFOs, debentures, market linked noted, VC funds, LRS, real estate funds and so on.
Investors often end up with one of three bad choices.
-Invest in an alternative asset or NFO without really incorporating it in their asset allocation framework.
-Invest in a safer liquid fund (to be moved “later” into equities) or bank fixed deposit.
-Buy a property because it is available at a “good” price, although they may be overweight on real estate and may not have a positive outlook on its future returns.
These are not bad choices in the sense that the investment avenues are inherently bad. Standalone, many of these products may be reasonably fine options. What is bad is the unplanned nature of this investment – triggered by a consideration other than risk and returns. That can be simplicity and postponement of the active decisions (while parking sums in FDs or liquid funds) or conflating the size of investment with its suitability (in the case of real estate or VC funds).
The net effect of all of these aspects is that investors remain under-invested in equities – typically way below their risk tolerance.
What can investors do differently?
The SIP orthodoxy that market timing doesn’t work ignores another behavioural trait of human beings. We do not like regrets. Also, we prefer stories to hard logic. Combine the two and one realizes that a coherent approach to timing one’s investments in equities may serve investors well.
It is perfectly fine to try and work out a sensible program of investing one’s lump-sum holdings into equity markets gradually. It is also equally fine to keep this program dynamic. For example, if I have to invest Rs 10 lakh in equities, I may invest Rs 1 lakh right away and plan to invest the next Rs 1 lakh if either the markets go down by 5 percent or if one month passes without that happening. I can also add ceilings to my program and postpone my investment if markets run up more than 10 percent in a month.
There are more useful metrics beyond recent returns to enable this. Price-earnings ratio of broad indices such as Nifty50 is a good guide – invest when it is low enough. It is currently at 33, which is fairly high. In general, a PE below 30 is acceptable; values below 25 are safer. Some investors also add earnings growth or GDP growth to the mix – higher growth allows a higher PE ratio. There is a lot of academic literature on this topic and investors can build their own rules to create programs for one-time investments using those.