Retail investment: Twin issues of timing and pricing

In India, stocks have out-performed other asset classes like bank deposits, gold and small savings by an impressive margin during the last 40 years, The Sensex, which was 100 in 1979, is now around 39000, multiplying 390 times in 40 years. This translates into an average annual return of 16 percent excluding dividend. This return is substantially superior to returns from other asset classes like bank fixed deposits (9 percent), small savings (slightly above 9 percent) and gold (10 percent), during this period.  In spite of this impressive wealth creation through the stock market, the fact remains that only a minority of investors have benefitted from this. Large numbers of retail investors haven’t benefitted mainly because of two behavioral traits associated with retail investors.  These are: one, wrong timing and two, wrong pricing.

Usually, retail investors enter the market at its peak. They jump on to the bull bandwagon hearing news of investors having made a fortune. The FOMO (Fear Of Missing Out) factor drives their entry into the market. Also, they invest predominantly in low-priced low-grade stocks. When the bull market ends and the inevitable correction begins, they panic and exit from the market. This wrong timing is a prescription for financial disaster.

The second, and very common behavioral trait of retail investors is wrong pricing; that is, in the bull market they buy more when the price rises and in the bear market, they buy less when the price falls. This is, unfortunately, the exact opposite of sound investment strategy.

SIPs in mutual funds can address both these problems of timing and pricing. During market corrections, when price comes down, SIPs enable buying more units at the same price. This ‘rupee cost averaging’ together with the power of compounding in the long run facilitates steady wealth creation. SIPs in mutual funds also address the problem of retail investor bias towards low-priced inferior quality stocks.

It is important to understand that even though stocks deliver superior returns, the returns are highly erratic and volatile. There will be periods of mediocre returns and periods of spectacular returns. An extended period of poor returns should not discourage the investor.  Poor returns indicate that good returns are imminent.

Fortunately, now, Indian retail investors are maturing as evidenced by the resilience of SIPs. But sections of investors continue to make the mistake of trying to time the market by stopping SIPs at the wrong time. It has been proved time and again that patient systematic investment is the key to wealth creation. Sometimes, the market will test the patience of investors. This is one such period. As we know, there are some challenges being faced by the economy. But India has the resources and capability to overcome these challenges  and march ahead. Investors have to keep their faith in the India Growth Story, invest systematically and wait with patience.