There is money to be made when one invests in a bad market. Then when the market picks up, even if it takes years, the returns are much more impressive than when one invests systematically. Yet, systematic investing is still so often promoted when investing in a diversified equity fund.
Let’s say you channelised a huge chunk of your savings into the stock market in January 2008 when the Sensex was at around 21,000. There was no way you could have predicted the market peak. You can well imagine the worth of your investment by December 2008 when the Sensex dipped to a pathetic 8,500? Psychologically, the impact of seeing the value of your investment mercilessly tumble is disastrous.
On the flip side, neither are any of us in a position to determine when the market has hit rock bottom. And even if you were capable of doing so, would you have jumped into the market in December 2008 when widespread panic reached fever pitch and harbingers of doom were of the opinion that the world would never recover from the global economic meltdown?
When you invest a lump sum in a diversified equity fund, you are instantly hostage to market timing. This will work only if you can time your buys at all market lows and sell your investments when the market peaks. In theory, all this sounds very appealing and, worse still, doable. In reality, it is quite the opposite. Investors flock to the market when it is on a roll and head for the exit when it begins to slide.
It is for this precise reason that a systematic investment plan, or SIP, is recommended when investing in diversified equity funds.
It enforces discipline and consistency in investing. The pressure on your resources is low, if at all, since you are expected to part with small sums of money every month which are automatically deducted from your bank account. Such an investment strategy helps you ride market upheavals to your advantage. And it categorically does what you aim for - accumulate wealth over the years in a low-cost, transparent fashion without a strain on your finances.
SIPs are expected to curb volatility, both on the upside as well as downside. This is done by cost averaging since the investments are made on a periodic basis, and not at one go. Though the investment amount is fixed, more units are purchased when the market trends downwards, and fewer units when the market moves up. So in a rising market, the SIP allows for new purchases to be made at higher costs. This impact is then nullified during a market decline. In such a market, an SIP performs better because it helps mitigate the effects of falling share prices, whereas the lump-sum method puts all the capital at risk in the market at once.
Markets move through cycles. You will experience a sideways market, an up market, a down market and plenty of volatile phases. The lump-sum approach, by its nature, involves market timing, and that's a dangerous game to play. Most important of all, systematic investing offers investors peace of mind and provides a smoother, more consistent entry into the market. It fosters a level of investing discipline. Rather than trying to figure out the best time to invest a lump sum, a systematic approach helps investors conquer bad habits such as increasing their exposure to equity only when the market is up.
So if they get their market timing absolutely bang on everytime, lump-sum investors may amass more wealth over time, though opting for SIPs is more realistic from a logistical and psychological standpoint. It can help overcome some of the psychological impediments that can bedevil investors, especially the difficulty of staying disciplined with their investment programmes in tough markets. Finally, at the most basic level, most people simply don't have lump sums to invest.
