In the world of investments, there is a well-researched theory of how human emotions play strongly at the wrong time. We all know that the markets are cyclical in nature. When the markets are cheap, typically there is a whole lot of negative news. Forecasts of the economy and the stock earnings are estimated to be on their downward slope. No one wants to invest in the stock markets when people anticipate negative news.
Driven by emotions, investors tend to extrapolate the good and bad markets. No condition prevails in perpetuity. Individual investors in the past have exhibited investment behaviour driven a lot primarily by two emotions, greed and fear. The equity market rally witnessed during 2004 to early 2008 is a case in point. What appeared a healthy stock market run up during the initial years turned out to be a highly irrational one with market valuations (measured in terms of P/E ratios) hitting sky high levels in January 2008.
Ironically, that exactly was the time individual investor’s invested maximum amount of money. FY 08 saw net inflows into equity mutual funds to the extent of over Rs. 52,000 cr which was nearly double of the earlier year. However, post the market fall the inflows dried up significantly, there were actually net outflows from equity mutual funds. In the next three years, after the sub-prime, the cumulative flow was negative 6000 crs. The pessimism and optimism of the scale was not warranted.
Peter Lynch managed Fidelity Megellan Fund for a long period of 1977 to 1990 and delivered an annual average return of 29 percent. He quotes that an average investor got only 7 percent in this period. Invariably there is a difference between the scheme returns and investor’s folio returns. This occurs largely because of the investor taking calls to time the market depending on what he /she reads across various sources.
Sir Isaac Newton is considered to be one of the most intelligent persons ever born. He has to his credit the establishment of the law of gravity and motions of planets and stars. As a mathematician he invented calculus. With that level of Intelligence, one would assume that the simple task of Investing would be a cake walk. But how many of us know that Newton lost his life’s savings while investing. After Newton’s financial collapse, he allegedly said, ‘I can calculate the movement of stars but not the madness of men.
Benjamin Graham, the author of Intelligent Investor writes, ‘this kind of intelligence (investing) has nothing to do with the IQ or SAT scores…. This kind of intelligence ….is a trait more of character than of the brain’.
Time and again it is established that patience has more value than intelligence when it comes to investing.
It is for these reasons that equity investors find it difficult to make money from equity. Is there a way to insulate ourselves from these dominant emotions, which over-power at the wrong time? Even as the problem sounds like a huge one, the answer to this question is a surprisingly simple and a highly effective one. Systematic Investment Plan (SIP) is an automated process of investment which gets triggered at a pre-defined frequency and regularly, making investment insulated from emotion driven errors.
Our mind adjusts to the debits from the bank…have heard many investors say that when it comes to writing a cheque for any investment there are multiple thoughts that plague them, where as if there is a direct debit from their bank account, they somehow do not get perturbed. The same principle is responsible for the irrational spends we make on plastic money rather than on physical money. An SIP is a simple tool that helps bring in the discipline required to tide over emotions.
Equity Markets reward long term investors. Since SIPs work on the principle of incremental investments at different points in time / index level, investors tend to stay invested and not time the market to exit impulsively. They should be made aware that SIPs work best for longer duration for effective compounding to work in their favour.
Most difficult things in life can be achieved through discipline. Building wealth is no different. Start an SIP today!
Author is Senior Vice President & Head - Products & Marketing, HDFC Asset Management Co. Ltd.
Disclaimer by HDFC AMC, "The opinions expressed in this article are those of the author alone and not of HDFC AMC, and should not be regarded as investment advice. Investors should obtain their own independent advice before taking a decision to invest in any securities." MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol are their own and not that of the website or its management. Moneycontrol advises users to check with certified experts before taking any investment decisions.