SYSTEMATIC INVESTMENT PLAN (SIP) TO FACE VOLATILITY IN THE STOCK MARKET



The global financial crisis brought havoc to many capital markets world over. Investors have lost millions of dollars in stock markets as almost all stock indices have been beaten down. In India the BSE Sensex crashed from a peak of 21207 in January 2008 to a low of 7697 in October that year, a fall of 64 percent. However the recovery was faster, at least in India, than expected. The economy has shown some resilience in many sectors and is expecting a GDP growth of 8 – 8.5 per cent during the current fiscal. The Sensex has regained some of its lost ground and reached present level of 17500, an impressive rise of 127 percent since the low of October 2008. The investors are showing renewed interest in stock market and their over all confidence level has improved a lot.
The unprecedented growth of share prices in recent time in the secondary market has created greater volatility in share prices. It is the small and retail individual investors who are likely to bear the brunt of volatility and suffer losses in the long term. According to experts the volatility is likely to stay in Indian capital markets and retail investors are advised to follow the Mutual Fund route to investment in financial assets. Generally investors have a tendency to hold a diversified portfolio to reduce the risk of insolvency. Holding this principle an investor may pick up stocks from different sectors rather randomly at different points of time. But this strategy may not work during a period of high volatility in the market. In this context one can follow the SIP approach to equity investment to his advantage and convenience.

Meaning of SIP

Systematic Investment Plan or SIP is a self disciplined approach to investment where the investor keeps apart a specified amount at definite interval and invests the same in shares or mutual funds. It operates like a recurring deposit in a post office or a bank. The investment accumulates over a period of time in a systematic way keeping the cost of acquisition at average level by smoothening of the fluctuations in prices. It is suitable for investors having regular income and also having regular saving habits.



SIP in Portfolio Investment

The SIP is widely applied in mutual fund investment where the investor gives post dated cheques for convenient amount as low as Rs.50 per month which the fund managers regularly collect and invest in units at current NAVs. The same mechanism can be followed in investment in shares in stock market under SIP provided the investor has the patience and discipline in making investment. It is not ideal in a single stock investment but works better with a portfolio of equity investments. SIP is ideal for those beginners who have little exposure to the intricacies of stock market investments. It is equally beneficial to those experienced investors who lack discipline and often commit errors acting upon sentiments.
Empirical studies prove that Equities have been regarded as the most rewarding investment among all asset classes. A study made by Jeremy Segal relating to the return of various investments during the past two centuries indicates a mind-boggling return on equity investment compared with other investments.

$ 1 invested in 1802 Value of investment in 2002 (in $)
Gold 0.09
Treasury bills 307
Bonds 1072
Dollar ( Currency as investment) 0.07
Equities (Dow Jones Index) 5974485
Source: “Future of Investing” By Jeremy Segal http://www.jeremysiegel.com/index.cfm/fuseaction/Display.Page/page/books.cfm

In India one can make a just analysis of the Sensex between 1978-79 and 2009. The index was 100 in 1978-79 (the base year of Sensex). It appreciated nearly by 212 times over a period of 29 years when it recorded a peak of 21207 on January 10, 2008. The cost of one ounce of gold was $810 in 1979 whereas the same costs only $872 in 2008 after a period of 28 years. Though real estate has emerged as an asset class in recent years and the return is also decent and comparable with that of equities, it needs large investment of money and not easily affordable to small investors. Equity investment is also attractive from the point of view of liquidity, convenience in dealing, transparency and strong regulatory framework.

The Indian capital market has come of age and is now comparable with any of the developed capital markets of the world. It is working under well regulated and transparent environment. There are around five thousand actively traded listed companies in the two national level bourses of NSE and BSE. At least two hundred of them have really emerged as investment worthy from a long term perspective attracting investor interests including that of Foreign Institutional Investors. There is good dissemination of corporate information and average individual investors are well-informed and reasonably well protected.

Long-term Perspective of the Market

Investors should approach the capital market with a long term perspective. A lot of investors do not do any research as they should or collect as much information as possible before selecting scrips for investment. Many of them act on tips or rumours or based on some analyst's price target, without doing their own research. Investors who take decisions based on emotions especially greed and fear, rather than sticking with some investment strategy, are to some extent gambling.

There is a big difference between buying a government security to collect the interest it earns and buying shares of companies. When an investor puts money in a company he has to realize that he is not simply purchasing a piece of paper but really patronizing a great business and its progress. Business and industry that these shares represent follows the principle of organic growth which takes time and patience. The progress is subject to frequent ups and downs as also the movement of the stock market. It is time that smoothens out these fluctuations. Therefore, the investor should have a long-term perspective of at least 3 - 5 years to take the benefit of equity investments.

Stock Identification

The responsibility for identifying the stocks and making investment regularly lies with the investor under SIP. The identification and selection of scrips are very important since the investor is accumulating particular scrips over a period. It is ideal to select the shares of blue chip companies with consistent track record and very good future prospects. The investor should identify few growth stocks from different sectors based on a fundamental analysis. He may also seek the help of a good investment expert or consultant in this regard.



The SIP Design

The three pillars of SIP are: (1) The power of compounding, (2) Cost averaging and (3) Hassle free investing.

The Power of Compounding

Under SIP the investor is committed to make regular investment at periodic intervals. Investment made elsewhere yields a return and better the opportunity higher will be the return. The power of compounding is not understood by many investors which explain the accumulation of wealth in the long run. It also points out the need for starting investment at an early age. Let us explain with an example: A and B save Rs. 100 per month. A starts at the age of 20 and B at the age of 30 but both retire at the age of 58. Assuming 10% interest rate the cumulative value of their savings on retirement would be Rs.5,16,034 and Rs. 1,83,059 respectively. A’s savings have almost trebled over the period only because he had started investing at an earlier age. The compounded sum would be much higher if the interest rate assumed is also higher. For example, the sum would be Rs.22,99,940 and 5,11,781 respectively if the interest rate is 15%.

Rupee Cost Averaging

Timing of investment is essential for maximizing return. Prudent investment decision advocates buying at low and selling at high. But it is easier to say rather than to practice. It is nearly impossible for a small investor to regularly monitor the market and take appropriate investment decisions especially in a highly volatile market. In such situations he can adopt the technique of Rupee Cost Averaging (RCA) where the investor picks up securities at regular intervals subject to the amount available under SIP. It follows the logic where the market price is higher he accumulates only small quantities and where the market price is lower he accumulates larger quantities. Investment under SIP is made on the assumption that every time is an opportune time for accumulation of growth stock and current market price of the stock is the price a discerning investor is ready to pay for acquiring the same. The idea is to see that cost of acquisition of shares comes down when acquired over a longer period of time.

Hassle free Investing

The demat account, online and internet trading, faster settlement, all these made securities investment much easier, less time consuming and most economical these days. The concept of market lot has no place in demat system of holding or transacting shares and the investor can place order for just one share of any listed company. The convenience of picking shares at any time of any quantity of any company helps an investor to accumulate a particular share or even build a portfolio under SIP over a period of time. SIP has all the advantages and convenience of hassle free investing.

Benefits of SIP

The SIP obviates the need for timing the market. Every time is an opportune time under SIP and the investor makes investment at all levels of the market. In the contest of equity investment it is more important that where to invest and how much to invest rather than when to invest.
The important advantage of SIP is the small size of the amount required for investment at a time. So it is affordable to even to people with very low income who want to build a portfolio over a period of time.
The investor can keep his cost of investment at average level under SIP even if there are wide ups and downs in the market since the securities are acquired at different points of time. This is not the case where occasional investments are made with substantial amounts.
The investor has a long term perspective towards investment under SIP. There is a disciplined approach and the investor is not confronted with the problem of when to invest or how much to invest.
The investor has the option of liquidating the investment as and when necessary or may redeem in instalments called Systematic Withdrawal Plan (SWP).
Conclusion
Equities remain as an excellent asset class if the investor has a long-term time horizon and a disciplined approach. But volatility of stock prices is an inherent feature of the equity investment. Investors should realize that decline in stock prices is temporary and short lived but increase is secular and permanent. The SIP route to approach the stock market would do wonders to the investors who have the patience and calmness to realize that equities are for the long term.

read my article

Copyrights©Dr.A.M.Viswambharan