In 2014 the Sensex surged by 30% giving handsome returns to equity investors. Mutual funds saw the highest inflows in over a decade. The start of the New Year has not been great for equity markets. In just about a week, the Sensex fell by nearly 1000 points. There are questions about the global economy especially the situation in Europe and crude. Some retail investors are waiting on the sidelines for a deeper correction to get into equities. The question for such investors is, "what is the right level to enter this market". As per some market pundits, we may see a further correction over the next few weeks which may take Nifty to 7,800 – 7,900 from the current levels of around 8,280 if the market gets negative global cues. There are others who are of the opinion that Nifty may test its historical highs before a significant correction. This scenario may pan out, if ECB steps in with quantitative easing, crude prices bottom out and if our corporate earnings are not disappointing. There are yet others, who believe that the Nifty will be range bound in the absence of any major event and mixed earnings. The point is that, equity markets are uncertain in the short term.
Large sections of the retail investor population missed out on the bull market from 2012 to 2014. While it is natural for retail investors to be wary about equities after a prolonged bear phase, a lot of investors simply kept waiting for correction once the market ran up significantly. It is not as if we did not have corrections in the last 2 years. We had a quite a few, but with every sharp correction these investors thought there would be more downside to the market. The important point to note about bull markets is that, after every sharp correction the pull back is very strong and the market goes back to pre-correction levels in no time (please see the chart below).
We can see in the chart above that, rallies after corrections have been quite sharp. Bull markets do not give enough time for investors to enter after corrections. In fact, investors waiting for corrections, often end up buying at much higher levels. Disciplined investing by averaging your purchase cost is a much more prudent approach for long term investors, than trying to time the markets.
Let us understand with the help of an example. Let us assume we are in 2013. You invested in a disciplined systematic way by investing in the Nifty on the first working day of every month throughout the year. The average value for your investment in Nifty would be 5,908. Your friend, on the other hand, wanted to time the market. While it is impossible to know if the market is at its lowest level, let us assume for the moment that your friend was very lucky. He got it spot on and invested in Nifty on August 28 at 5,285 which was the lowest level of Nifty on a closing basis in the last 2 years. Apparently compared to you, your friend got a great bargain. But let us now be realistic. It would have been practically impossible for your friend to know on August 28 that 5,285 would have the bottom of the correction. In fact since Nifty was on declining trend from June to August that year, he would have waited beyond August 28 to see if it corrected further. If he waited for 7 days, Nifty would have been at 5,680 which is just 4% below your average cost. If he waited for 15 days, he would have invested in Nifty at a higher cost than your average cost. Such is the nature of bull market. Buy on dips is the age old investment advice for bull markets. Disciplined investing, such as mutual fund systematic investment plans (SIPs) ensures that you can buy on dips rather than waiting forever for a deep enough correction.
As per finance text book definitions, volatility is a measure of risk. By its very nature, equity as an asset class is volatile. While bear markets are usually characterized by higher volatility, even bull markets are volatile. But is volatility is the same as risk for long term investors? It is true that, we as investors get jittery with volatility. There are mutual fund investors who made 30% in the last one year, ready to jump out if the market fell by 5%. Good diversified equity funds gave compounded annual return of over 20% over the last 10 years, even including the prolonged bear market phase, when the market fell by more than 50%. Why should a 5% correction matter to the long term investor? Once the investor understands the nature of a multi-year secular bull market, the investor should be able to ride out the volatility and get good returns over a sufficiently long investment horizon.
There are three phases of a multi-year secular bull market.
In this article, we have discussed that timing a bull market is difficult. Investors should follow a disciplined approach by investing in mutual fund systematic investment plans to get good returns to take advantage of volatility and buy on dips. Investors should not be worried about volatility and have a sufficiently long time horizon to benefit from the power of compounding. Most importantly, investors should ensure that their asset allocation is aligned with their investment objectives.
An Investor Education Initiative by ICICI Prudential Mutual Fund to help you make informed investment decisions.
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