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Aarati Krishnan

IN December, when the Sensex was tantalisingly close to the 6,000 mark, I was tempted to shift more of my savings into stocks. In May, as the market crashed on post-election jitters, I wondered whether I should be pulling all my money out of stocks and stuffing it into the mattress!

Most of us are familiar with the basic investment tenet that says that you should buy stocks when the market is down in the dumps, and hold off when it is up and swinging. But, simple as it sounds, this rule is quite difficult to follow! Some of the worst investment decisions happen when we churn our investments frenetically in an attempt to buy (or sell) at the right time.

How it works in real life

Systematic investing, or investing in the stock market through equal instalments spread evenly over time, helps us avoid precisely such mistakes.

Also known as dollar cost averaging in investment parlance, phasing out your investments in stocks through monthly or quarterly instalments has a couple of advantages. It helps you stay in the market through its ups and downs, without making any conscious attempt to time your purchases.

Second, when you invest the same sum of rupees, say Rs1,000 every month, in the stock market through the years, you automatically buy more shares (or units of a fund) when the market is low, and less when the market is buoyant. This is exactly as it should be.

Live examples of systematic investing show that had you invested regularly in equity funds with a good track record over the past ten years, you would have done much better than the market and earned a reasonable return on your investment, to boot.

Had you begun investing in October 1994 and invested Rs 1,000 every month in Franklin Bluechip Fund for the next ten years, your total investment of Rs 1.20 lakh would have grown to Rs 4.99 lakh by now, delivering an annualised return of 15.3 per cent.

But, remember, selecting a fund with a track record of consistently beating the market is important. A similar systematic investment in the Nifty basket would have delivered a measly 3.9 per cent return over the same ten-year period.

Should you spread out a lumpsum?

Suppose you have come by a windfall from a rich uncle and are prepared to invest this money in the stock market. Should you take the plunge right away or choose to dribble the money little by little into the market through systematic investing?

Surprising as this may seem, many financial experts argue that you should probably take the plunge right away, investing the whole sum at one go. This argument is based on the logic that if held for a long period, stocks do deliver much better returns from other asset classes.

If you have a sum that you are willing to risk in the stock market, why not put your money to work right away in stocks? Phasing out your investment over many months is akin to postponing your investment, which may result in missed opportunities.

A live computation spanning a 10-year period shows that investing a lumpsum in stocks has, more often than not, delivered higher returns than systematic investing in the Indian context too.

Assuming you had Rs 1.20 lakh to invest in October 1994 and invested it right away in Franklin Bluechip Fund, your investment would today be worth Rs 6.56 lakh. Instead, if you decided to take the systematic route and invested Rs 1,000 every month in the fund, while retaining the rest in a bank account (earning an assumed 5 per cent a year), your investment would now be worth just Rs 5.39 lakh! Your annual return from the systematic investing strategy, at 16.2 per cent, is a full two percentage points lower than that from the lumpsum strategy, which earned 18.5 per cent.

If you compared the returns from lumpsum investment to that from systematic investment at the end of every month for the ten-year period, the lumpsum strategy would have fared better than the systematic investment about 65 per cent of the time!

Systematic investing more practical

But despite these numbers, an ordinary investor should probably choose systematic investing over lumpsum investing, for two reasons.

For one, few of us start out with a good idea of how much exactly we would like to commit to stocks, at a particular point in time. Granted, if you have Rs 5 lakh to invest and do not mind losing 40 per cent of this sum to stock market swings, then taking the plunge at one go makes as much sense as systematic investing. But for most of us, setting aside a portion of the monthly paycheck for stocks is easier.

Second, even if we had a lumpsum to invest, few of us are really equipped to handle a substantial erosion in the value of our investment, even if it is temporary.

Systematic investing does not protect your equity investment from the swings in the stock market. But it does do a good job of reducing the impact of bad timing on your entire portfolio, by limiting the amount that you commit to stocks at any single point in time.

Good shield against downside

An extension of the above 10-year example proves that systematic investing has indeed done a better job of shielding your portfolio from the downside risks of the stock market.

A lumpsum invested in the stock markets on October 1, 1994 would have no doubt earned you a handsome annual return of 18.5 per cent had you stayed on till date. But to earn this, you would have had to stay invested through some nerve-wracking swings in the value of your investment.

For instance, the value of your lumpsum investment would have plunged 46 per cent in value at one point in February 1997, before climbing back over the next couple of years. And such occasions were all too frequent.

If you checked your investment at the end of each month after investing in October 1994, you would have faced an erosion in capital in as many as 42 of the 120 months since then. No doubt, the stock market has rewarded the intrepid few who have stayed on with a handsome return. But these "shocks" can be debilitating if an unforeseen contingency forces you to pull out funds from the market, ahead of when you thought you would need them.

While investing a lumpsum has been a nerve-wracking experience, a systematic investment strategy has done a better job of protecting you from sharp swings in investment value. If you systematically invested Rs.1000 every month in an equity fund since October 1994, you would have registered an erosion in capital in 35 of the 120 months since, fewer times than with the lumpsum strategy. The maximum loss that you would have faced would have also been substantially lower at 36 per cent, instead of 46 per cent in the lumpsum strategy.

Systematic investing has worked even better if you had a portfolio of equities and fixed income investments. If you had Rs 1.20 lakh to invest in October 1994, but decided to shift just Rs 1,000 every month into the Bluechip Fund (retaining the rest in fixed income investments earning 5 per cent), there would have not been even a single month when you faced an erosion in your principal.

In fact, over a 10-year period, systematic investing has delivered better results in India than it has in the American market.

This is because negative returns from the stock market have been a more frequent occurrence in the Indian market than in the US during this ten-year period.

Checks and balances

If these numbers convince you that systematic investing is really best for you, do remember the following before you write out the cheques:

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