How does SIP work when markets fall?

It is natural for even the most disciplined investor to get anxious when markets are volatile and accumulated wealth starts deviating from the desired growth path. The most instinctive action in such conditions is to stop further investments and even withdraw accumulated wealth if volatility persists. But, would that be a wise thing to do? Probably not.

Volatility is inherent to equities. It is practically impossible to forecast how markets are going to behave on a certain day. When markets plummet, investors tend to stop their SIPs or redeem their investments.  However, experts believe that in such times, investors should stay calm and steer clear of the noise and volatility. Investors should look at the long term goals and should continue with their SIPs in mutual funds and forget the noise. Financial planners always suggest that investors should link their SIPs to their short and long term financial goals and continue the SIPs until the goals are reached. With SIPs, you can make continual and steady progress towards your financial goals without waiting to accumulate a large amount before investing.

Month Amount Invested NAV Units bought Total Units bought Average Cost
Jan 2,000 14.53 137.646 137.646  
Feb 2,000 11.93 167.645 305.291  
March 2,000 10.67 187.441 492.732 12.38
April 2,000 8.86 225.734 718.466  
May 2,000 7.62 262.467 980.933  
June 2,000 8.84 226.244 1207.177 8.44
Total 12,000   1207.177    

 

A dip in the markets is not reason enough for investors to stop their SIPs. A dip in the market gives them a chance to add a higher number of units to their portfolio. If an investor stays invested for the long term, the equity markets will go through a number of ups and down, and in some of these times; they are bound to see negative returns. In the long term, equity market returns follow nominal GDP growth rates. Hence, investors should continue their SIPs irrespective of the ones giving negative returns. 

 

As you can see above, each SIP installment of Rs. 2,000 is able to buy more number of units in the fund as the NAV decreases in value, except for the month of June, wherein, investor receives less number of units, when compared to the previous month (May), because, the value of NAV is higher when compared to that of the previous month. Another way for an investor to look at this table would be to see the benefits from a lower average cost. Suppose, the investor had stopped his SIP midway, after the 3rd month, the average cost would have been Rs.12.18 (Amount invested Rs. 6,000 divided by Total units bought 492.732) which is much higher than Rs.9.94 (Rs. 12,000 divided by 714.445 units) if an investor continues his SIP till the month of June.

Impact of Withdrawing SIPs midway

Experts believe that, for an investor to enter the market at peak levels is a bad move, and for them to exit at low levels out of panic, is another such bad move. They believe by remaining invested over the long term through market ups and downs, using the SIP investment strategy, to be continually invested, is a smart way to build wealth.

Let’s analyze what happens if an investor withdraws all their investments mid-way? From the above table, if an investor had withdrawn all their investments after the month of June, the invested amount would have been impacted in two ways. Firstly, the value of their investment (Rs. 8.84×1207.177units = Rs. 10671.44) may be lower than the investment (Rs. 2,000×6 monthly installments = Rs. 12,000) made by the investor.

Secondly, the investor shall be charged an exit load from the fund house for redeeming their investments within a year. Exit load charges cannot be reversed and every fund house has a minimum stipulated time, usually, it is 365 days or 1 year.

What should an investor do if a scheme returns have turned negative?

In order to judge a scheme based on the returns received, one year is too short a period to take a call on the scheme. Experts believe that an investor should give any scheme/investment in SIPs at least three to five years to perform.

However, if any mutual fund scheme underperforms its benchmark over a three-year period, then, it is highly recommended that an investor takes a closer look at the mutual fund scheme or move his investments to another scheme, which has a better performance.

Alternatively, if the mandate of a scheme has changed, or the fund manager has changed, it is important and highly recommended that an investor discusses these changes with an advisor or any such professional, before arriving at a decision on whether to move his investments. 


Note: The given examples are for illustration purpose only & shall not be construed as indicative yields/returns of any of the Schemes. Past performance may or may not be sustained in the future.

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