The recent turn of events in the global market has led many investors to question their investment decision, and now everyone is running from pillar to post to pull back their invested capital in numerous market-linked instruments. Disruption in supply chains owing to coronavirus pandemic, fall in oil-prices and the rising uncertainty in the minds of investors, has led to a steep fall of the stock market indices.
Consequently, investors are taking out money fearing future loss. Here we’ve analysed how SIPs of Mutual Funds at this point can help mitigate the risk and pave way to high capital appreciation in the long run, when the bourses are back in full swing.
What is Market Correction?
It is a bitter truth that stock markets are dynamic and volatile in nature, a platform that has witnessed numerous rags to riches stories, and the opposite of this is equally true. Market correction refers to the fall in stock prices, usually preceded by a short-term increase in the prices. It is called ‘correction” because of the fact that this fall doesn’t last long, and the market “corrects” itself to bring the prices back to normal.
Often market correction doesn’t last long, since the market forces work together to bring the market sentiment back to normal. However, if the phase lasts for more than a couple of weeks, it might lead to a creation of bear market, a period when securities fall more than 20% from their recent highs, owing to pessimistic market behavior.
Market Correction has a significant impact on your invested capital, especially if you have substantial allocation to equities. As the stock prices fall, investors lose on the existing capital gains, and if the phase persists for long, the possibility of capital loss also becomes high.
What is a Systematic Investment Plan?
Systematic Investment Plan (SIP) refers to regular investment of small amounts of money in a mutual fund scheme at predefined intervals. It instils disciplined investment habits amongst investors who find it difficult to save. Apart from this, investors also benefit from Rupee Cost Averaging (RCA) strategy, power of compounding, etc if they choose to invest via SIP in Mutual Fund Schemes.
How SIPs help during Market Correction?
When the economy is in full swing, and the stock market is delivering positive returns, everyone is attracted towards it and wants a share. Although, when the market enters a bearish phase and the portfolio starts reflecting negative returns, majority of the investors choose to stop their SIPs. But this decision to halt the SIPs cannot be more wrong.
A steep market correction has often been seen as the best time for new investors to enter the equity market and leverage the possibility of making huge capital gains in the long run. SIP has an in-built mechanism that helps to tone down the losses incurred during a market correction. This happens because of the rupee-cost averaging feature of SIP.
Rupee Cost Averaging is an investment strategy which eliminates the need to time the market. Through SIP one invests a pre-decided amount in the fund which essentially ensures that one buys fewer units of shares when the markets are expensive, and more units of shares when the markets are cheap. This practice reduces the cost per unit. Ultimately, investors end up with better returns at a lower risk.
For instance, suppose you start a SIP of ₹1000, which is deducted every month. In a rising market, if the Net Asset Value of the fund is ₹40, you’ll get 25 fund units in a month. When the market correction happens and NAV of the fund falls down ₹20, you’ll acquire 50 fund units in a month, if you continue your SIP. In the long run, you’d have accrued a significant number of fund units, and when the market bounces back, you’ll be in a better position as opposed to investors who stopped their SIPs during a market correction.
Conclusion
The strongest antidote to a falling market is patience. You have to endure the market correction without reacting to alarmist headlines or panicking. Media headlines tend to amplify the dangers of a falling market during these times and investors should learn to ignore them. You should instead focus on your financial goals and have a long term investment horizon to build your wealth. Happy Investing!