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Mutual Fund | September 01, 2023

The Game of Compounding & Timing for Mutual Funds

"Forget about timing the market, it doesn't work. You will lose money. Invest for the long haul and then sit back and wait -- the market always goes up in the long run." - Paul Farrell

Often we hear investment experts say that it is better to invest time in the market instead of timing the market. While this holds for traders who trade on a daily basis, and their profits are generated from different prices at different times in the market, for an investor, it is better to invest more time in the market, to understand how it is working, and then invest, and in such cases, chances of earning positive returns increases.

That said when investing in the equity market for a shorter period, entering and exiting the market at the right time can be crucial. However, predicting the future of any stock or even the overall market accurately every time is something beyond the capabilities of a human brain or even AI cannot do so.

However, does this concept hold for mutual funds as well? Often you will see people asking if is it a good time to invest in mutual funds or not, which is a valid question but the answer needs a little explanation.

Is there any right time to invest in mutual funds?

While there is no thumb rule related to the timing of investing in mutual funds, the timing of investing should change according to the type of funds you are investing in or the duration for which you want to stay invested and most importantly the mode of investment – SIP or Lumpsum.

Since, mutual funds also invest in the same asset classes like equities, debt, alternative investments, and others, thus, while investing a lump sum in a mutual fund, you need to think about the timing a bit. This especially holds for equity mutual funds and if you are investing in them for a shorter duration.

When the equity market goes up, the NAV of the equity mutual funds or funds having major portions of equity and equity-related instruments also tends to increase. This makes the units of the fund expensive and thus, if you are thinking about lump sum investment during market highs, you may end up with a lesser number of fund units.

Especially if you are looking for mutual fund investment plans for short term then you should avoid investing in higher NAV funds as markets are volatile and you may never know, when the time of redemption comes, the market may decrease leaving you with losses.

Thus, if you are investing a lump sum amount in a mutual fund and for the short-term then always try to invest in funds with lower NAV or during the market lows for the asset class in which the fund invests.

Is there any other way to invest in mutual funds without worrying about timing?

To keep all the hassles of timing the market and your mutual fund investments at bay, you can consider investing in SIPs.

SIPs are Systematic Investment Plans, which do not depend on market timing. Rather the more time you stay invested the potential for higher returns increases.

Investing in mutual funds via the SIP route has increased drastically in the last few years, especially during the Covid-19 pandemic since the SIP route helps investors invest in the funds on a regular basis, without worrying about whether the markets are at a high or low.

How do SIPs help in achieving investment goals without timing the market?

SIPs lets you invest every month and you can invest small amounts starting from even Rs. 100 or Rs. 500 depending on the fund. If you are wondering how these small investments can help you achieve your investment goals, then you need to know about Rupee cost averaging.

Rupee Cost averaging helps in mitigating the timing factor involved in mutual fund investments. Here you invest a fixed amount at regular intervals irrespective of market ups and downs and the averaging out of the prices at which the mutual fund units are bought helps in generating better returns for the investors rather than a one-time investment or timing the market.

Let us understand this with an example.

Suppose you started an SIP of Rs. 10000 for an equity mutual fund. The NAV of the fund at the start of the investment is Rs. 60 and the most popular equity market index, Nifty is at the 21000 level. Let's see how it will work –

Month SIP Amount (Rs.) Nifty Equity Fund NAV (Rs.) Fund Units
January 10000.00 21000.00 60.00 166.67
February 10000.00 20200.00 52.00 192.31
March 10000.00 20400.00 54.00 185.19
April 10000.00 20200.00 52.00 192.31
May 10000.00 19800.00 48.00 208.33
June 10000.00 19600.00 46.00 217.39
July 10000.00 19400.00 44.00 227.27
August 10000.00 19800.00 48.00 208.33
September 10000.00 20200.00 52.00 192.31
October 10000.00 20400.00 54.00 185.19
November 10000.00 20600.00 56.00 178.57
December 10000.00 20800.00 58.00 172.41
Total Investment 120000.00 Average NAV 52.00 2326.28

The above table showcases how Rupee cost averaging would work. Now, if you wanted to time the market, and invest the entire amount in the month of January when the market was high compared to the next few months of the year, then at the NAV of Rs. 60, if you had invested the entire Rs. 120000, then you would have bought only 2000 units of the fund. With the help of rupee cost averaging in the SIP route, you get 2326.28 units of the funds for the same amount invested.

Now you may say, if you had invested when the market dropped in July Nifty touched 19400 and the NAV of the fund became Rs. 44, then you would have got 2727.3 units of the fund. However, can you be certain of when the market will drop and rise? Even Warren Buffet or our very own Rakesh Jhunjhunwala could not.

This is why investing in mutual funds via SIPs using the rupee cost averaging effect helps retail investors as well as HNIs generate better returns over the long term.

If you want to invest for the short-term, then you can invest in debt mutual funds, and avoid equity mutual funds as the equity funds are more volatile than debt funds or invest when the market is at a low, but then again you cannot be sure.

Final thoughts

Therefore, instead of looking for the right time to invest in mutual funds, you should start today, and go for long-term investments, as markets rise in the long-term especially when it comes to equity markets. Moreover, you do not have to worry all the time and keep track of the market to invest in your favourite funds. All you need to do is chalk out a plan of investment and invest regularly to achieve the maximum returns without taking higher risks.

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