By Parthajit Kayal and Renuka Venkataramania
The participation of retail investors in the Indian stock market has been impressive in the past few decades. Most of them are risk-averse and prefer to invest for the long-term. Empirical evidences show that high frequency traders time the market and make reasonable amounts of profits while retail investors have no edge when it comes to market timing.
This is because the decisions of individual investors are influenced by their values and sentiments and market timing requires a high accuracy rate in prediction. Systematic Investment Plan (SIP) is an alternative investment strategy for retail investors to yield significant returns in the long run without having to follow the market trends.
What is SIP on stocks
SIP is a popular investment strategy among mutual funds. However, SIP on individual stocks can yield higher returns than the pre-determined mutual funds provided the stocks in the basket are chosen carefully. This is a strategy where a fixed number of shares or a fixed amount is invested in an individual stock for a fixed date of every week/month/year throughout the investment horizon. SIP employs Dollar Cost Averaging method wherein the average cost per share is always less than the average price.
Empirical evidences from our study “Systematic investment plans vs market-timed investments” show that in a long-term investment horizon, weekly, monthly, quarterly or yearly SIPs yield similar returns with negligible difference in most cases. So, the frequency of SIP does not influence the returns much in the long run.
Why SIP investment is good
While timing the market, investors tend to make mistakes in determining the entry and exit points. They might be out of the market during an appreciation and lose out potential returns. Using SIP, the investors employ a buy and hold method and stay in the market throughout the investment period. Taking advantage of the market fluctuation, SIP profits from volatility where more shares are bought, when the share price is low and fewer shares are purchased, when the price is high. SIP encourages regular savings, provides an excellent tax efficiency, protects investors from trend chasing and prevents investors from making a single ill-timed purchase.
What type of stocks perform better in SIP?
In the study, we employed SIP and absolute momentum investment strategy on individual stocks for different investment horizons and found SIP a suitable long-term investment strategy for least or moderately volatile stocks. Retail investors prefer less risky stocks and evidences show least volatile stocks yield relatively higher returns when invested systematically in the long run. This is termed as a low volatility anomaly.
Similarly, for a long-term investment period, SIP on stocks of firms with at least 15% return on capital employed (ROCE) yields higher returns. In the recent time frames, SIP on non-PSU stocks produce relatively higher returns than the PSU stocks as the latter are mostly high-volatile stocks. So, SIP is a preferred long-term investment strategy for least volatile, non-PSU stocks with high ROCE and strong fundamentals such as low debt-to-equity ratio, high promoters’ holdings, growing sales volume, high operating margins, etc.
Moreover, SIP decreases cognitive biasness in the decision-making ability of investors and thereby reduces the exposure to regret. Retail investors in the direct equity market should embrace the SIP way of stock investment instead of trying to make investment decisions depending on market directions and expectations. However, selection of stocks is critical for making a long-term investment decision through the SIP way.
Kayal is assistant professor, Madras School of Economics and Venkataramania is a recent graduate, Madras School of Economics