Insights

Is the correction good enough to invest?

October 22, 2018 . Ashwini Arulrajhan

Markets have been falling steadily over the past two months. The Sensex and the Nifty 50 have lost more than 12% and the broader markets have seen a deeper fall. The astute investor will see this correction as an opportunity to buy on lows, especially after the long bull market of 2014-2017. The more important questions then become, is this a steep enough correction to buy? Are the markets going to fall even more? Well, nobody can time market highs or market lows. But you can still take advantage of corrections without being carried away by these concerns. Here’s how.

Don’t wait for steep corrections

The table below shows the historical corrections since 2008. It is evident that a steep fall like the one during 2008 translated into tremendous returns later. But if we look at the recent years, we have not seen corrections like that. Corrections in the recent years ranged between 7% and 12%. But here’s the good news – even those falls, if used to average efficiently, would have perked up your returns.

Periods of correctionCorrection6 months later1 year later2 years later3 years later5 years later
Jan 2008 - Oct 2008-59%34% 101%140%  93%129% 
Jan 2010 - Feb 2010-11%15%14%10%25%85%
Jan 2011 - Feb 2011-15%-2%-1%13%17%42%
May 2011 - June 2011-8%-13%-9%13%38%53%
Jul 2011 - Dec -2011-20%11%27%37%88% 75%
Mar 2012 - Jun 2012-11%21%24%52%74% 95%
Jul 2013 - Aug 2013-12%16%42%57%56% 110%
Mar 2015 - Jun 2015-11%-5%1%18%34%
Aug 2015 - Sep 2015-12%-1%14%28%55%
Oct 2015 - Feb 2016-16%21%23%56%
Nov 2016 - Dec 2016-7%21%27%
Jan 2018 - Apr 2018-9%7%
Aug 2018 – Oct 2018*-13%

*As of Oct 11, 2018

What’s more, markets periodically provide such opportunities. The table below shows the number of months which saw at least an 8%-13% correction in the last 10 years. This re-emphasizes the point that running SIPs will help you make the best out of volatile markets.

No of months which saw5 years7 years10 years
More than 8% fall173356
More than 10% fall132545
More than 13% fall71530

Use opportunities systematically

We have spoken enough about the benefits of SIPs. The first and most important benefit is that SIPs bring in a discipline in investing and ensure that you don’t compromise on building wealth. The second key benefit is that it helps you avoid mistiming your investments, since you run SIPs across market cycles.

But for investors who want to actively take advantage of volatile markets, using every correction to add on will help average costs even lower and allow you to accumulate more when markets are cheap. It makes your SIP more effective. The question is, of course, at what point during the correction should you invest? As we’ve said several times, it is not possible to call out highs or lows before they happen.

The best route is to use cut-offs and invest a small amount in addition to your SIP every time the market fall breaches this cut-off. The cut-off can just be a certain fall from the 1 year market high. There are several advantages to this method.

One, you do not leave it up to prediction and guesswork into whether or not the correction will continue; this allows you to actually catch a fall instead of losing the opportunity. Two, it allows you to catch even the shallower corrections as explained above. Three, investing smaller amounts is practical, since you may not have a large enough surplus to invest on a low; typically, investing a large sum on a steep decline is needed to bring costs down. Four, it is not too complicated a strategy to follow or execute.

To empirically test the results of this method, we did the following. Say, you were running a SIP of Rs 10,000 for the last 5 years. By investing every month, you would have anyway bought on few of the falls. You are willing to put aside a certain amount of surplus to invest more during falls. Every time the market falls more than 10% from its 1-year high, you decide to add on a third of your SIP amount, that is, Rs.3000.

 Normal SIPSIP + Investing in lows
Investment Amount6,00,0006,39,000
Final Value7,59,8098,11,856
Gains1,59,8091,72,856
XIRR9.37%9.53%

*Returns as on Oct 15,2018

In the last 5 years, there were 13 instances where the market fell more than 10%. If you had invested on those dates, you would have invested Rs.6,39,000 against Rs.6,00,00 in your regular SIP. By investing Rs.39,000 extra, you would have gained Rs. 13,047 during the 5 year period. And that is good returns, considering the extra investment amount you put in.

Smart investing vs timing the market

We have, time and again, advised against timing the market. Does this amount to timing the market? In a way, it does. But this method is smarter that waiting for the low that proper market timing would require. And while you are waiting for the low, markets race past you, only for you to spot a low in hindsight.

You could also flip our argument to say that one needs to stop investing at highs – what if you stop investing every time the market moves up a certain cut-off from the low? Stopping SIPs would immediately hurt your goals, since you would be investing lesser – who knows where a rally would stop? The other option is to invest lower at highs. For that, we have the answer and that is the value averaging plan! If you’re an experienced investor, you could use VIP more effectively than an SIP. Or something as simple as rebalancing (moving to your original asset allocation) on an annual basis can help sweep some profits from equity to debt.

What we are telling you here in this article is to invest smartly. By observing these patterns that repeat themselves, we know that markets are going to keep providing you such opportunities. It may not be a 60% fall like in 2008, but a 10%-13% fall is still enough for you to enhance your returns.

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