As in cricket, so in investing, it’s all about finding the delicate balance between playing out the tough overs to launch an all out attack when the wicket flattens out By Dharmendra Satapathy
Using systematic investment plans (SIP) in mutual funds is perhaps the best wealth medication for people of this nation because
- India is a young country and the resource of “time” is available
- India is a developing country and hence people have income but less wealth
- Hence people are capable of investing small amounts for the long term, the ideal mix for wealth creation over the long term.
But despite this opportunity
- Why are people shying away from starting their SIP in a mutual fund?
- Why is it that people feel there is a big risk in starting an SIP in a mutual fund?
- What is the nature of this risk?
What Is The ‘Risk’ Of Investing? Is It Different Than What We Think?
‘Risk’ in the mind of an investor is about losing his money. While the practitioners see ‘risk’ as volatility, the helpless customer sees it as losing his hard earned money. It is crucial to bridge the perception gap of ‘risk’. Unless this gap is bridged how people will step up their investments and pave a path to walk into a promising future.
Understanding ‘Risk’ The Ipl Way
Watching Indian Premier League (IPL), I stumbled upon an idea to help people understand the concept of risk of investing. What better way to explain than through the most endearing lens of IPL?
In every IPL game, the batsmen are meant to score big in every over. After all they just have 20 overs to play. But a keen follower of the IPL game knows that it does not pan out in this manner. The batsmen have a different strategy, which is:-In every IPL game, the batsmen are meant to score big in every over. After all they just have 20 overs to play. But a keen follower of the IPL game knows that it does not pan out in this manner. The batsmen have a different strategy, which is:-
The batsmen play a guarded game against good bowlers and reserve their hitting power for the weaker bowlers. If Chennai Super Kings (CSK) plays Mumbai Indians (MI), the CSK batsmen would be guarded against Lasith Malinga but would go after say a Vinay Kumar who appears easier to score against as compared to a Malinga. Most of the time this strategy works and in just few big overs the batsman compensate for their silence against Malinga.
The batsmen use the opening overs when field restrictions are in place to take their chances, go over the in-field with lofted shots and make quick runs. The run rate is usually high in the first 8 overs. The middle overs are used for consolidation. It’s the time of the game when the batting team tries to stitch a good partnership and conserve wickets even though run rate climbs down to say five runs per over. The final five overs are built upon the success of middle overs. If wickets are in hand and if the run rate has been good you can expect big hitting in the final five.
Sometimes it could be 80 runs in 5 overs which takes the final run rate to somewhere between 8 to 10 runs per over.
The Investment Connect
In the same manner investments in mutual funds too score in an inconsistent fashion. Some years when the market is bullish and when the environment positive (when the bowling is easy) ‘returns’ are high and in other years when the mood is somber and the markets are bearish (when the bowling gets difficult like a Malinga over) the ‘returns’ are low. But ultimately in the long term the returns are reasonably good just as in the IPL the run rate at the end is usually respectable.
‘Risk’ in the mind of an investor is about losing his money. While the practitioners see ‘risk’ as volatility, the helpless customer sees it as losing his hard earned money
It is seen in an IPL match that usually no two overs are alike as far as runs per over are concerned. Every over is treated based on its merit. Hence the run rate is not consistent across the overs. The final run rate is derived from the final score.
‘Investing’ is similar in conceptual sense. While we do say that ‘returns’ over the past 20 years is 15%, it does not mean that in every year of let’s say a 20 years investment journey would fetch a return of 15%. There could be some years in this period when the fund returned 50% and there could be some years when the fund returned even a minus 10%. In years when the market is bullish, one often gets to see markets gallop northward. On other occasions when market is bearish markets spiral southward.
Hence like the IPL run rate, which was not consistent across overs, the investment returns too are not consistent across the years. This mix of years returning 5%, 10%, 25%, 100%, 0% etc. throws up a final asset value which determines the ‘returns’ just how the final score determines the run-rate.
In an IPL game it is a few big overs in between that change the tempo of the game. A few overs of 15 to 20 runs per over when the bowling is weak substantially take the overall run rate up. Similarly a few great overs from say Lasith Malinga can dry up the runs bringing the run rate down.
It is similar for SIP investing where the investment buys more units when the markets are stumbling like how sixes are smacked when the bowling falters. Additional units purchased during the market ‘lows’ accelerate the final “return” just like runs made in big overs raise the run rate. Likewise during the bull phase when the markets are rocking the SIP investment buys lesser number of units just like when runs dry up during a great bowling spell.
Units purchased during market highs retards the ‘returns’ just as one or two great Malinga overs can take the game away from the batting side. Clearly bad market conditions are good for long term returns just as a bad bowling leaking away runs is good for the team’s final run rate.
Understanding Risk Of Investing
The above examples show the inconsistencies of scoring ‘runs’ and scoring ‘returns’ and herein lays the intended meaning of ‘risk’ of investing.
- ‘Risk’ is the volatility or inconsistency in run rate over the 20 overs of an IPL game and likewise in the inconsistency of returns over the years of SIP investing.
- Therefore one should understand that in the case of a mutual fund investment the ‘risk’ is certainly not of losing money just like in an IPL match the risk is never about a team-scoring zero at the end of 20 overs.
In sum, one should keep investing across different market cycles. You never know when you’ll get the opportunity of scoring big. Hence keep the investment effort systematic despite the changing environment.
Written By: Dharmendra Satapathy is the Founder Director, Next Level Education