Managing Emotions with SIP

In our previous editions of Weekend Bytes, we have discussed various tenets that an investor could adopt to reduce risks while investing in equities, namely, tenet 1 – Diversification, tenet 2 – Thinking Long Term and tenet 3: Mutual Funds over Direct Stocks. In this edition, we discuss tenet 4 – Managing Emotions with SIP.

Scott D. Cook once quoted - “If you cannot control your emotions, you cannot control your money!”

Why is there a need to control your emotions?

As discussed in this series, although equities have the potential of providing growth in the long term, the short term poses risks. With equity markets being volatile in the short term, investors’ emotions also tend to also become volatile.

But what if we said that Systematic Investment Plan (SIP) is an effective technique for managing emotions?

Benefitting from “Averaging”

Equity markets tend to uctuate between high (overvalued) and low (undervalued) levels. While the objective is to buy when levels are low and sell when they are high, it is dicult to do so on a consistent basis. With SIP, the average can be captured eectively.

Rupee Cost Averaging is a technique wherein one can invest a particular amount in a mutual fund every month (or every day / week / quarter) through the ups and downs of the market movement of a mutual fund's Net Asset Value (NAV).

By virtue of this (or SIP), an investor would benefit by buying more units when the market is down, and less units when the market is up.

Let’s consider the case of an investor doing an SIP of INR 10,000 per month in the Growth Option of HDFC Flexi Cap Fund - Regular Plan. The graph below illustrates the number of units of the fund purchased with the movement of its NAV.

2 inferences can be drawn from the graph above:

Onset of the pandemic: Equity markets took a hit, leading to the Fund’s NAV to fall, which led the investor to purchase a higher number of units during the fall

Recovery from the pandemic and geopolitical tensions: Equity markets started to rally, leading to the Fund’s NAV to rise, which led the investor to purchase a lower number of units

Effectively Managing Emotions

In the short term, Greed and Fear can take the front seat when investing for the long term. This is because when there are excesses in the stock market, greed sets in, which in turn results in major correction, thereby triggering the fear psychology. Most investors get trapped in the greed and fear cycles by buying in greed and selling in fear, resulting in a bad investment experience. In that light, SIPs can be effective in managing emotions because the investment amount can get automatically debited on a periodic basis, leading to higher investing discipline with little impact of various macroeconomic and market events.

Requiring Minimum Sacrifice

Successful investing involves 4 mantras, those being:

Start early
Stay invested
Invest regularly
Ensure asset allocation

While investors believe that investing require sacrificing a significant portion of their savings, the illustration given below busts this myth wide open:

In addition to the above, SIPs in mutual funds give investors the option of starting their investing journey with a very nominal periodic amount – as low as INR 100 for most of the HDFC MF Schemes!

Conclusion

With the reasons mentioned above, while SIPs can aid an investor's investment journey, one should start investing early. This is because a small delay to start the investment journey could cost significantly in the long term (Illustration given below).

As discussed in this series, by thinking long term, an investor could use SIPs as an investment route to unlock the true potential of compounding. Over the course of this 4-part series, we have discussed multiple key tenets that help in reducing risks while investing in equities, but what is next?

But are there more techniques to reduce risks while investing in equities?