With the market crash due to worldwide COVID-19 outburst in the last few days, many of my friends have asked me: “Should I stop Equity Mutual fund SIP payments for 1-2 months since the market is too risky and may further go down?”. Yeah, I agree market is too risky and volatile currently, but still you should NEVER EVER stop a SIP installment during a market crash. To understand the reason, let us first see in brief what is SIP and how it reduces investor’s risk.
SIP, or Systematic Investment Plan is a method by which we can invest in mutual funds by paying fixed amounts regularly, in fixed intervals, be it weekly or monthly basis. This creates a sense of discipline in the investor’s mind and reduces the risk involved with investing a lump-sum amount.
Let us see how Mutual fund SIP reduces the risk with an example:
Suppose the NAV (Net Asset Value: the price of 1 unit) of a fund as on March 1 is Rs 100. A market crash happens and the NAV decreased by 30 % (Sensex fell by ~32% in last 40 days), which made the new NAV Rs 70 as on April 1.
You and your friend both got an amount of Rs 1 lakh as bonus from your employer. Both of you decide to invest the complete amount in Equity mutual funds.
Your friend invested the complete amount of Rs 1,00,000 as a lump-sum amount in a mutual fund on the March 1. So, the number of units he gets allotted is 1,000.
You are smart, and you invest Rs 50K on the 1st of every month in mutual funds using SIP. So, the total units you purchased on March 1 will be 500 (Rs 50K invested at an NAV of Rs 100) and on April 1, you purchased 714.2857 units (Rs 50K invested at an NAV of Rs 70).
As on April 1, Your friend only has 1000 units in his portfolio which is equal to Rs 70,000. You, on the other hand have 1214.2857 units in your portfolio which makes your portfolio value to Rs 85,000.
Yes, you also suffered a loss of Rs 15k, but it is exactly HALF the loss suffered by your friend. Also, in the long run, you hold more number of units of the fund than your friend. So, your portfolio value will be more.
Some might see it the other way, what if the market rises by 30% in 1 month? In such case, the lump-sum investment will give higher return. Yes that is true, but history shows that the market does not go up with the same rate it comes down. The total gain market gave in the last 3+ years got wiped out in the last 40 days due to the recent crash. You get the gist of how fast the market crashes??
So, the chances of ‘lump-sum beating SIP’ is way too less than the chances of ‘SIP beating lump-sum’ in long term. If you are thinking of stopping your mutual fund SIP payments during a market crash, simply DON’T. Instead if you have some extra money, keep investing little amounts in intervals and buy assets on ‘sale’. Don’t miss out the chance, you never know when everything comes back to normal and the market starts recovering again.
There is a very basic rule in investing: “Higher the risk is, higher the return and lower the risk is, lower the return”. I’d any day prefer a decent 15% return with a 30% chance of suffering a little loss over 25% return with a 75% chance of suffering a massive loss when market is volatile.
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Hi! I’m Gaurav, a Software Engineer by profession and a credit card enthusiast by heart. I love earning reward points and cashbacks from credit cards and giving ‘gyaan’ on credit cards and personal finance.