Downtrend offers good investment opportunity

It is a universally acknowledged truth that greed and fear are the enemies of investing, more so while investing in the equity market because they cloud knowledge and discipline. In the current scenario, investors in the equity market may be anxious about market levels with the S&P BSE Sensex and the Nifty 50 poised at record highs.

Investors should avoid these emotions and stay focused on their financial goals by taking a disciplined approach to investing.

Historical trend shows herd mentality.

Buy low and sell high is the basic thumb rule for all investors. But investors typically forget this rule because of behavioural biases. The herd mentality is a perfect example of this behavioural bias. Investors tend to move in a herd while investing, buying more when markets are on the rise, and reducing or selling their holdings when markets are on a downturn. Emotions such as fear and greed cause investors to take investment decisions with a lag. For instance, when the market was at a peak in 2007-end, investors invested heavily in equity funds under the influence of greed.

On the other hand, when the market fell sharply in the 2008 crisis and remained sidelined for the next five years, investors consistently withdrew money from equity funds.

Again, inflows started rising only after 2013 when the market showed a clear uptrend. More recently too, equity funds witnessed outflows in March 2016 following the downtrend in March 2015–February 2016. Ideally, a downtrend provides a good investment opportunity for investors.  Because of this lag effect, investments get negatively impacted in the long term. Investors have invested and redeemed their investments based on market movements. In doing so, they have earned 11.83% annualised returns (IRR) in the past 10 years from equity funds (CRISIL – AMFI Equity Fund Performance Index).

On the other hand, equity funds have given 11.87% annualised returns on a point to point basis during the same period. While the return difference is not much, it does not factor in the costs borne in terms of exit loads, capital gains tax, etc. and the reinvestment risks for the investors who churned their portfolio. Thus, it simply means that, instead of churning their investments, had investors just stayed invested over the long term, they would have benefitted from the market.

Regular investing keeps emotions in check

Moreover, had the same investors invested a fixed sum regularly on a monthly basis in equity funds, they would have made annualised returns of 15.39% (IRR) during the same period. Hence, regular investing makes investors disciplined and helps them to rationally sail through the peaks and troughs of the market cycle. Investors can use the systematic investing plan (SIP) route over the long term to derive optimum returns from the market. By investing regularly through SIPs, investors also enjoy the benefits of rupee cost averaging (buy low when markets are high, buy high when markets are low).

In the current scenario where the markets are at all-time highs, many investors are stuck in this greed-fear conundrum. In a rising market, both making a lump sum investment under the influence of greed and staying away from investing due to fear can be imprudent. Instead, an SIP can be an ideal solution to this conundrum. For instance, suppose an investor had invested through an SIP in an equity mutual fund at the previous peak (January 2008) of the 2003-07 uptrend, when the Nifty 50 was trading at all-time highs and continued it till date (July 2017), his/her investments through the SIP would have made a return (IRR) of 15.79% as compared with 8.37% annualised point-to-point returns in the same period.

Thus, investors should avoid making the investing mistakes engendered by greed and fear and instead, optimise their returns by regularly investing in equity mutual funds for the long term.

(The writer is Senior Director, Funds & Fixed Income Business at CRISIL Research)