The Indian share market is already is up nearly 30 percent from its recent lows. The recovery has been faster than anyone expected. This has happened despite the coronavirus pandemic – the trigger that brought about a massive selloff in bourses across the world and is nowhere close to being contained.
Are you one of those who regret having missed the bus when the market was at its absolute bottom? But can you predict a bottom and anticipate the peak?
No one can as share price movement is a function of, among others, anticipated earnings of companies, general economic environment, fund flows, and buyer-seller equilibrium.
Since predicting the rise and fall of share prices on a daily basis is next to impossible, how to make the most of the volatile share price movement? The answer is one SIP at a time.
How does SIP work?
As the name suggests, systematic investment plan or SIP allows you to buy certain amount of shares of a company or units of a mutual fund at a regular interval with the amount you pledge to invest over a period of time. You can choose to invest daily, monthly or quarterly. You can begin with as little as Rs 500.
Since you stagger your purchase over a period of time, your average price invariably is lower than the peak price and higher than the bottom price. The probability of earning a decent return therefore is quite high in the long run.
How does averaging work?
Suppose you buy 10 shares of HDFC bank at the current price which is close to Rs 1,000. Let us assume that the price of HDFC Bank share falls to Rs 900 next month around the same time. With the same amount of Rs 10,000 you will be able to buy nearly 11 shares of HDFC Bank. In two months, you will have 21 shares of HDFC Bank with an average purchase price of Rs 952.
If you continue to do so month after month, your average price is going to take care of volatility and you will end up with a large portfolio of HDFC Bank shares. Since the average cost is lower than the peak price, chances of getting a decent return are much higher.
But will the return from SIP will be lower than absolute return from direct investing in case of bull market?
That can happen only when you buy at a price which is closer to the bottom and sell when it is at the peak level. Let us say you purchase 100 shares of HDFC Bank at Rs 700 a piece and sell at an average price of Rs 1,000.
You will end up making a lot of money. That can happen only when you begin with a big investment and are absolutely sure of a vertical rise in the share price of HDFC Bank. Since vertical rise rarely happens, you can make decent returns even with small sums invested regularly through SIP. What is more, by entering the market at different price points with small sums, you minimise your risk.
What is amount-based SIP and how is it different from quantity-based SIP?
Both of them work with the same principle of investment at the pre-determined interval. In the quantity-based plan, you plan to, for example, buy 10 shares of HDFC Bank every month.
In the amount-based plan, however, you agree to invest a fixed amount, let us say, of Rs 10,000 every month. Benefits in both the cases are identical.
Do regular mutual funds fetch better returns than SIPs?
In a raging bull market when share market keep rising for months without a pause, regular mutual fund portfolio tends to outperform SIPs. Since that rarely is the case, SIP is considered a better and safer route.
It has benefits like: Starting with a lower sum, not bothering too much about timing the market, benefit of aligning the investment horizon with major financial goals and flexible entry and exit options.
What if you default on making payment on time?
There is no penalty for non-payment in SIP. Your fund house may choose to stop the SIP in case you do not make payments for three months in a row.
However, whatever you have invested will keep giving return and you can redeem it too, whenever you want. Once you get investible surplus again, you can choose to start yet another SIP.
What kind of companies should you invest in through SIP?
As stated earlier, you can choose to buy units of mutual funds or directly invest in shares of companies. While selecting companies you should go for companies with a proven track record.
Companies like HDFC Bank, Hindustan Uniliver, Reliance Industries, ITC, Larsen and Toubro, HDFC, Bajaj Finance, ICICI Bank, TCS, Infosys and Maruti have been some of the companies that have given consistent return over a fairly long period of time. They are likely to give decent returns in future too, once the economic environment stabilises.
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