It is recommended by many financial experts that the Systematic Investment Plan (SIP) not be stopped when the market is observed to be turning downward or when the markets turn volatile. Many investors are inclined to suspend their SIPs as soon as any sign of market instability is seen. This knee‐jerk reaction is often triggered by a desire to cut the potential losses that are assumed to be imminent. However, it is strongly advised that such a decision is not taken lightly.
The SIP is designed to continue over time so that wealth is gradually built, and it is believed that long-term progress is achieved when the SIP is allowed to proceed without interruption.
In this blogpost, a detailed explanation is provided on how the SIP plan should be strategized, even during periods when market downturns or when volatility are experienced. The benefits that are expected to be realized through this consistent investment approach are explained further in the sections that follow.
Table of Contents
The Misconception of Market Timing
It is often stated that the market is capable of being timed by making careful predictions about its highs and lows. However, it has been demonstrated that the concept of “timing the market” is not only unreliable but is also considered by many to be a myth. The Indian stock market has recently been seen to experience selling pressures and volatility.
Many retail investors have been left in a state of confusion as they attempt to determine whether the market has reached a peak or if it is nearing its bottom. Questions are frequently raised about whether the SIP should be paused at a time when the market is high or even when it is low, in an effort to avoid potential losses.
It is understood that the temptation to protect one’s savings by attempting to time the market is very strong. Yet, it is believed that pausing the SIP on the assumption that a market decline will occur soon may result in the loss of future gains.
A question is often asked: “Has the investment been started when the market was at its lowest, and did the market continue to fall after the entry point?” If the answer has been found to be in the affirmative, then it must be concluded that the initial market assumptions were mistaken. In this manner, it is suggested that a pause in the SIP should not be initiated solely on the basis of expecting a market fall.
It is understood that the market is influenced by a strength that causes gains and by a weakness that results in declines. As such, any decision to sell or to suspend the SIP when the market is either strong or weak is considered to be unwise. It has been noted that the regular, automated contributions made through the SIP are not meant to be adjusted on a day-to-day basis. It is believed that predicting the market’s fluctuations consistently is nearly impossible, even for experts.
Consequently, when the SIP is stopped because of a belief that the market is at its peak, potential future gains are likely to be missed. It is a fact that historical data shows the market has tended to move upward over the long term. Therefore, it is recommended that even if some of the best months are missed, consistency in investing should not be compromised.
The Principle of Rupee-Cost Averaging
The concept of rupee-cost averaging is one of the primary benefits that is associated with SIPs. It is understood that the process of rupee-cost averaging is applied when a greater number of units are purchased during periods when prices are low, and fewer units are bought when prices are high. Over time, it is expected that the average purchase price of the units will become balanced, and the impact of market volatility is thereby reduced.
For example, it is imagined that a SIP of Rs. 1,000 per month might have been initiated five years ago in a mutual fund. During periods when the market was low, it is likely that 100 units were purchased in a month. In contrast, when the market was high, it is assumed that only 50 units might have been acquired. In this way, it is ensured that a larger number of units are automatically accumulated at lower prices. It is believed that this accumulation of more units at lower rates can be highly beneficial when the market eventually corrects itself.
It is maintained that rupee-cost averaging allows the investment cost to be spread over a number of purchase points. As a result, the overall risk that is associated with market volatility is diminished. The effectiveness of rupee-cost averaging is underscored by its ability to average out the purchase cost over time. In this way, the negative impact of market fluctuations is reduced, and a more stable growth in wealth is encouraged. It is recommended that this mechanism be allowed to work continuously through the uninterrupted operation of the SIP.
Restarting the SIP after a Suspension
It is recognized that when a SIP is first initiated, a specific goal is set in relation to saving and investing. A question is then raised as to why the SIP is being considered for suspension at a later time. It is suggested that if the reason for stopping the SIP is based solely on the market being perceived as extremely high or low, then the decision may not be justified. It is believed that significant reasons, such as a change in financial objectives or a dramatic shift in personal circumstances, should be the only factors that justify the halting of the SIP.
If the SIP has been suspended because of a fear of a market correction, it is important to be aware that the market typically experiences retracements after any strong rally. It is observed that after a significant market surge, a period of retracement is usually experienced. This retracement is considered to be a temporary phase, which is followed by a renewed upward trend. Historical data is used as a guide to show that after a robust rally, the market is likely to retrace before it continues to move upward.
It is suggested that rather than being halted indefinitely, the SIP should be resumed as soon as it is felt that the market has stabilized. It is understood that any prolonged suspension of the SIP may result in the loss of opportunities that arise from subsequent market gains. In this manner, if the SIP has been paused due to market fears, it is recommended that a clear plan is put in place for its restart. The plan should be based on an analysis of the market conditions and a recognition that market movements are often temporary and subject to change.
Historical Insights into Market Declines
Historical market data has been examined in order to determine if a consistent rule can be applied when assessing whether the market has reached its peak. It is noted that there is no single rule that can reliably indicate the market’s turning point, but historical trends have been used to provide some insight. Instances from past market declines have been referred to as cautionary examples.
For instance, the market declines that were experienced in the years 2008 and 2020 are often used as examples for study. It is recalled that on January 18, 2008, the market (as represented by indices such as the Nifty 50) was observed to have fallen by approximately 5 percent in a single day. This decline was followed by an even steeper drop of over 8 percent on the subsequent trading day.
A similar pattern was observed during the market movements of 2020, when on March 9, 2020, a decline of around 5 percent was recorded, which was again followed by a decline of more than 8 percent on the following day.
It is maintained that these instances occurred when the market was perceived to be trading near its peak. However, it is also acknowledged that there were exceptional days when the market corrected by around 5 percent but recovered quickly, without leading to a major downturn. It is believed that such historical data should be considered as a guide, but it is also noted that reliance solely on these past trends is not advisable for making current investment decisions.
The evidence from these historical examples is used to emphasize that market movements are often subject to rapid changes. It is observed that even when sharp declines occur, the market may eventually recover. Therefore, a decision to suspend the SIP should not be based solely on the occurrence of a 5-percent drop in a single day. Rather, it is suggested that a more comprehensive analysis of market conditions should be undertaken before any drastic changes in investment strategy are made.
The Magic of Compounding and Patience
The principle of compounding is regarded as one of the most powerful forces in the world of investing. It is frequently stated that the benefits of compound interest have been described by Albert Einstein as the “eighth wonder of the world.” It is understood that when investments are made regularly through the SIP, returns are earned not only on the initial amount invested but also on the returns that have been reinvested over time.
A notable example of the benefits of compounding is provided by the late veteran investor Rakesh Jhunjhunwala. It is recalled that wealth was built through the patient holding of a stock, such as Titan Limited. It is believed that if the investor had sold the stock immediately after a 100-percent gain had been achieved, the full potential for wealth creation would not have been realized. It is maintained that by allowing the investment to remain intact and by continuing with the SIP even during market downturns, additional units of the asset are accumulated at lower prices. This additional accumulation is then compounded over time as the market eventually rebounds.
It is suggested that the compounding effect is disrupted if the SIP is stopped. When regular contributions are made consistently over a long period, it is observed that the compounding effect works in a manner that increases wealth exponentially. It is recommended that the SIP is maintained without interruption so that the process of compounding can work effectively. Any interruption is believed to have the potential to sacrifice significant long-term gains.
Investment Discipline and Consistency
It is often remarked that successful investing is not achieved by attempting to time the market but by maintaining discipline and consistency. It is agreed that investing is to be seen as a marathon rather than a sprint. It is understood that regular, disciplined investments—regardless of market fluctuations—are believed to keep one on track to meet long-term financial objectives.
It is observed that decisions to pause the SIP are frequently driven by emotional responses to short-term market movements. It is recommended that such emotional impulses be resisted in favor of a rational and long-term approach. It is believed that by keeping the SIP active during times of market volatility, discipline is maintained, and the long-term investment strategy is allowed to flourish. The temporary nature of market movements is acknowledged, and it is noted that these fluctuations do not alter the fundamental objective of building wealth over time.
It is further noted that when the SIP is continued even during periods of market uncertainty, the investor’s commitment to the long-term goal is reinforced. It is understood that this consistent behaviour is what ultimately leads to the creation of substantial wealth. Therefore, it is advised that the SIP be viewed as an essential tool for long-term financial success, and that short-term market volatility should not be allowed to derail the planned investment strategy.
Guidelines for Effective SIP Management
To obtain the maximum benefit from the SIP strategy, it is recommended that certain guidelines be followed. These points ensure that the investment process is both disciplined and aligned with long-term financial goals.
1. Choosing the Correct SIP Amount
It is suggested that the amount to be invested through the SIP be determined by following a goal-based investment process. The first step is to define the various financial goals that are to be achieved. Once these goals are established, the time horizon for each goal is to be ascertained, and a target amount is to be set. It is understood that for long-term goals, inflation must be taken into account.
After these elements have been determined, an asset allocation for each goal is to be decided upon, and an expected annualized return is to be assumed. In this manner, the SIP amount for each goal is calculated. Numerous online calculators are available to assist with this process, and it is recommended that these tools be utilized.
2. Budgeting to Ensure Consistent Investment
Once the appropriate SIP amount has been determined, it is advised that a monthly budget be prepared in order to ensure that the required investment is feasible. It is observed that if a gap exists between the available funds and the desired investment amount, expenses must be reviewed and adjusted accordingly. If the gap cannot be eliminated through budgeting alone, it is recommended that the SIP amount be increased gradually over time.
This practice, often referred to as the “step-up SIP,” allows the investment to be increased in alignment with the growth in income. It is believed that this strategy will help ensure that the financial goals remain attainable as the investor’s circumstances change.
3. Understanding and Utilizing Step-Up SIP
Step-up SIP is a strategy in which the monthly contribution to the SIP is increased on a periodic basis. It is understood that the SIP amount may be increased by either a fixed sum or by a set percentage every year. The primary advantage of this strategy is that it aligns the investment amount with a growing income, thereby allowing more capital to be deployed as financial capacity improves. It is believed that the effect of a step-up SIP is significant over long periods.
For instance, if an investment of Rs. 20,000 per month is made in equity funds through a regular SIP over a span of 20 years at an expected annual return of 12 percent, a corpus of Rs. 2 crore may be built. However, if the SIP amount is increased by 10 percent every year, the corpus could be expected to reach approximately Rs. 4 crore. In this manner, the power of the step-up SIP is observed to double the potential returns over the long term.
Concluding Thoughts on Long-Term Wealth Creation
As discussed in this blogpost, SIP is ideally suited for navigating the ups and downs of volatile markets.
The key points of this blog have been summarized as follows:
- SIP should not be halted simply due to short-term market volatility.
- The attempt to time the market is fraught with uncertainty and that historical evidence supports a continuous investment strategy.
- The mechanism of rupee-cost averaging is employed to reduce the impact of market fluctuations.
- Market retracements are common and should not be taken as a signal to permanently stop the SIP.
- The benefits of compounding, when the SIP is maintained, are significant and should not be interrupted by emotional reactions to market trends.
- A disciplined and consistent approach is regarded as essential for achieving long-term financial success.
In summary, the SIP has been designed to facilitate wealth creation over the long term. It is hoped that through a disciplined approach, careful planning, and the use of strategies such as rupee-cost averaging and step-up contributions, financial goals will be achieved. The market, in its long-term upward trend, is expected to reward those who remain invested consistently, regardless of short-term volatility.
Check out my other blogpost, wherein I have tried to put forth everything you need to know about Stock SIPs, and how to be consistent in Stock Market investing and wealth creation.
Do Follow me on Linkedin and Quora for more such insightful posts on investments, personal finance, insurance, money management, etc.
