One minute, the market’s hitting record highs, and the next, it’s in the pangs of a stock market correction. Market downturns are common and can be caused by several factors. Although history can provide us with facts on how long crashes, bear markets, and corrections have lasted, nobody gets a calendar notice announcing the nature, time, and projected magnitude of future dips in the stock market.

The stock market is not the real economy. Share prices can change for many reasons, such as to correct overvaluation, etc. In such a situation, several investors with low-risk tolerance either redeem their existing investments or stop investments altogether, like those through a SIP (systematic investment plan). But is it the right decision for investors to stop their SIPs during a market downturn? Let’s understand this better.

How do SIPs work?

Let’s understand the working of an SIP with the help of an illustrative example:

*Assume your monthly salary is Rs40,000 and you set aside 10% for your monthly SIP mutual fund investment.

Now, you begin investing Rs4,000 p.m. in XYZ fund in June 2005. Under this investment, Rs4,000 will be automatically invested in XYZ fund each month. One of the major advantages of SIP is the power of compounding it offers. The Rs4,000 that you systematically invest in SIP accumulates over the years to form a significant corpus. Between June 2005 and June 2015, you would have made 120 investments of Rs4,000 each into the XYZ fund. Today, the total capital invested would be Rs4.8 lakh (120*Rs4,000).

If you calculate the return on this investment @12%, it would have grown to Rs9.3 lakh; almost twice your original investment. Even if you adjust this against an expected inflation rate of 6%, your wealth would grow to Rs6.6 lakh in this period, i.e. a 50% appreciation of the principal invested.

You can use a SIP calculator to better understand the probable returns offered by your fund.

Should we stop SIP during market volatility?

If you are wondering when to stop your SIP investments, then let us tell you that it is never a good time to discontinue them. Discontinuing your SIP investments during a market downturn is perhaps the worst mistake you can make as an investor. It defeats the very purpose of SIPs by negating the opportunity to accumulate more units when prices go down.

A downturn is the ideal time for SIPs to actually work in your favour. SIP investments tend to work better in a fluctuating market scenario. As the market hits lows, resulting in a decline in a fund’s NAV (Net Asset Value), you end up buying more units of the fund at a lower price. Gradually, as the market starts picking, the value of your SIP investments could fetch more returns since you own more units now. This miracle is called Rupee Cost Averaging, also referred to as the eighth wonder of the world by some.

So, if you were to stop your SIPs during this period, you would not be able to seize this wonderful opportunity.

Let’s understand this better with the help of two scenarios: a bull market and a bear market.

*Mr. X starts an SIP investment of Rs10,000 per month in April 2019. Let’s see what happens:

Exhibit A: When the markets are low (bearish)

During these five months, Mr. X has invested Rs50,000 and accumulated 1,750 units. This is because as the NAVs dropped, more units got accumulated.

Exhibit B: When the markets are high (bullish)

In this phase, the NAV of the fund increases from Rs20 to Rs50 in five months but Mr. X has only accumulated 1,500 units.

In ideal circumstances, a fund’s NAV is bound to increase in the long run. Thus, having more units at this point will help investors receive a better payout on redemption.

Economic slowdown shouldn’t hamper you from investing in mutual funds. There are numerous indicators that illustrate that the market still has the potential to rise from the ashes. And when that happens, your investments are bound to shine. All you need to do is build a portfolio wisely with maximum diversification.

 What not to do during a market downturn?

There are several things that you should refrain from during a market downturn. These are:

1. Panic selling as stock prices fall
2. Attempting to time the market
3. Taking on a new debt
4. Agreeing to co-sign loans for others
5. Ignoring your investment plans and goals

While market downturns might seem scary, take a deep breath and understand that they will come to an end. This can be the key to your overall investment approach in the long-term.

As quoted by Benjamin Graham, who is referred to as the ‘Father of Value Investing’, ‘Successful investing is about managing the risks, not avoiding it’. If you stop your investments in SIP now, or worse, redeem your investments, you will turn your temporary loss into a permanent one.

Rather, it is a good opportunity to top-up your investments  through SIP based on your financial goals and risk appetite. Happy investing!

*Examples are for illustrative purposes only.