In recent times, I am getting the same question asked over and over again.
I just learnt about Index fund. I have lumpsum. Can I invest immediately now? or should I wait for a market correction.
This same question comes back to me over and over again in repeated mode.
Infact, this question was asked by Madhan in our Q&A series.
It just missed making up the list because of the thumbsup ratings.
That is actually good as this needs a separate episode to explain in detail.
This is that episode. Hello. My name is Vijay Mohan. You are watching Investment Insights.
Let us begin with some facts.
Fact #1 - No one can time the market. That is, no one can predict whether the market is going to go up or down in one year.
“Hello… stop right here. Who said that we cannot predict? Charts clearly shows it.
“What you are saying is not fact, but your opinion.” - if this thought is coming to your mind, this episode is not going to be of any help to you.
You can stop right here and save some time for yourself.
Fact #2: Market goes up in long term. We already saw that in “Risks in Index Fund” episode.
If that is true, then we have to maximize the time in the market for our money as much as possible. This is second fact.
Other than these two facts, we have to understand the concept of “Odds”.
That is, the probability of something to happen. Yeah, the same probability that we studies in our Maths class in our childhood.
A card deck has 52 cards. If I am taking one out of it, what is the chance of that card to be a Spade?
13 out of 52. 0.25 probability. That is 25% chance.
If that chance is over 50, it is a bet that is in our favor.
Let us say that we have multiple choices for making a decision. We should know which choice has the most chance to occur. If we know that, it is easier to make a decision.
When we play Rummy, don’t we favor waiting for end cards more than waiting for a middle card to make a rummy? Same concept.
Lets jump into the questions that we have about lumpsum investment.
To find the answers for all the questions, we are going to use the article written by Charlie in compoundadvisors.com.
Link is in the description.
Let us say that we have a lump sum of 1 Lakh or 10 Lakhs. We would like to invest.
Should we invest all immediately? or should we split the amount and invest every month?
The strategy suggested by many is to split the money into 12 parts.
Invest one part every month so that all get invested by the end of 12 months.
The justification for that is “Dollar Cost Averaging”. That is, in that one year period, market is moving up and down every day.
As we are splitting the amount for 12 months, we get the chance of buying it for cheaper price as well.
So our buying cost averages out is the rationale behind that strategy.
What is the problem with that logic? What did we see in Fact #2?
We saw that the more the time we give for our money, it has got better chances for growing.
That means, if we intentionally delay the investment by 12 months, we are reducing that chance of growth for our money.
That is first problem. Next problem is the rationale that we can buy cheaper over 12 months.
What if the market goes up and becomes expensive? So, what knowledge would help us here to make the decision?
At any given point of time, what is the chance for the market to go up or down?
If we know that, we can make the decision of whether to wait or invest immediately.
Charlie has shown this data in a chart in his article.
He has shown the difference in returns between lumpsum investment and splitting it across 12 months using S&P500 data from 1928 to 2020.
Lumpsum investment has 68% chance of beating this 12 month dollar cost averaging.
That means, dollar cost averaging method has only 32% chance of outperforming lumpsum investment.
Ok, instead of splitting it across 12 months, what if we split it across 36 months?
Then the chances of dollar cost averaging method to outperform goes down even further to 27%.
So what do we learn from this historical data? As we delay the investment, we continuously lose the chances of beating lumpsum investment.
Ok. Lets not split and invest. But we can wait for correction and invest right? That will give us chance to buy cheaper right?
Sure. We can buy for cheaper if the market corrects. But what are all the chances of that happening?
We saw that in “Risks in Index Fund” episode. The chances of market going down by at least 10% is once in a year.
“Oh really? then we can easily wait for it to happen…”. Sure.
But the problem is, that 10% down is from the top of the market.
The market could have gone up 20% since we planned to invest and come down 10%. Then essentially we would have missed 10% growth.
That is one problem. The other problem is, when the market goes down 10%, would we buy immediately?
We know what we do… we will wait further saying that market has already fallen 10%, it will come down further.
What happens next? Market starts going up. We would have missed that 10% down as well.
We will then realize that we should have invested in the beginning.
“Ok. Let us not target 10%. But what if we wait for a 20% down?”. The chances of that happening is once in 4 years.
Even if that happens, the chances of that price being lower than today’s price is only 21%.
It is not a good idea to wait for that as well. So it is not a good strategy to wait for a market correction or for bear market.
But valuation is expensive now. Could we wait till it gets cheaper, you may ask.
Before we answer that question, let us see how we are measuring market valuation.
We are using CAPE Ratio, which is “Cyclically Adjusted Price to Earnings” ratio, to measure the market valuation.
Share price of all 500 companies in S&P500 divided by 10 year average inflation adjusted earnings is the CAPE ratio.
If the price is high, the earnings need to be high to match that as well.
If the earnings is not high enough to match the price rise, then that will lead to this ratio to be higher.
We are looking at CAPE Ratio from 1928 in this chart. Historical average is close to 18.
But the current CAPE ratio is 37. That means, valuation is definitely at the higher end.
But even during the crash in March 2020, the valuation did not come down below 25.
That means, if we are waiting for the valuation to be cheaper, we might have to wait for many years.
Even if we wait for that long and invest when it was cheaper, could it have beaten the annualised return of lumpsum investment Today? No.
Charlie has shown in his data that is coming below the annualised return of lumpsum investment.
Another thing to note here with the CAPE ratio is, as the time goes, the average CAPE ratio is keep rising from historical value 18.
The average CAPE ration since 1995 is at 27.5. So we cannot really use this as a reliable indicator and wait for long time.
So, whichever way we look at it, investing lumpsum has better chances of giving better returns compared to waiting for a good time.
For this reason, many in USA, max out their 401K early in the year.
When it comes to stock market, the simple rule that we can follow is, if we have money to invest and if we do not need the money for at least another 5 years,
then it is better to invest in an index fund immediately and move on to other things in life.
What about SIP (Systematic Investmwent Plan) investment? We should definitely do that as well.
To invest our monthly salary consistently in an automated, disciplined way, SIP is the best.
Remember Fact #2. We are maximizing the time for our money to be in the market by investing the money from our salary immediately thru this automation.
Hope you understand the advantages of lumpsum investment now. Next, let us get into a controversial topic.
I have asked few questions about Groww app fiasco last week in our community tab. Thank you for all the participants.
The intention of those questions is not to find out whether Groww is safe or not.
But to understand how much we know about the last week incident and how much of our opinions were influenced by external factors.
Sadly our situation today is, only 25% of our opinions is our own opinion. But the rest 75% is forced into us.
Lets us begin with the news reported by Hindu Business Line about Groww App.
“Several of Groww App customers came to a rude shock. Their money in liquid funds were liquidated without their authorization and was invested in a NFO.”
This is the reported news. They have mentioned “several” customers here.
Groww has close to 1.5 Crore customers. How do we take it when they say a blank “Several” customers?
Do we take that as 10 customers or 10,000 customers?
The examples they gave for that “several” was two specific customers. Same article has Groww’s response as well.
“A total of 12,000 users invested in NFO. Among them, for around 100 users, the debt funds were liquidated and got reinvested in NFO.
“When we realized the mistake, we worked with the AMC to revert these transactions.” is the response from Groww.
Now, as a user, how can we digest this news? We can take all the knowns as “Facts”.
We can take the “unknowns” as our assumptions. What are all the knowns here?
First Fact - 12,000 customers invested in a NFO thru Groww app.
Second Fact - Debt funds were liquidated and reinvested in NFO fund for 100 users among that 12,000.
Third Fact - When the mistake was realized, the transactions were reverted by the AMC.
End Result - No customers were affected. Now we can form our own opinions based on these three facts.
The range of those opinions could be from calling them thieves to that this could be a honest mistake.
Now let us get into the responses for the questions.
First question - Did Groww steal money from innocent customers?
If we check our fact list, we dont see anything like that happened at all.
But still 65% of the responses were Yes. What could be the reason for that?
Could it because of following someone blindly? Or could it be from the confirmation bias that all brokerages are thieves?
Whatever it is, we should realize the weakness in our decision making.
For the follow up question of whether your response is a fact or your opinion - 65% responded as Fact and 30% responded as opinion.
It is at least OK to mistake a fact for opinion, but it is very dangerous to mistake an opinion for a fact.
Definitely learn the art of differentiating between a fact and an opinion.
For the next question of, how many actually lost money - though 30% of the responses correctly captured as 0, another 30% had a range of 100 to more 1000.
Do not assume anything. It is very dangerous in investments.
For the question of what % of users were affected - 60% acknowledged rightfully that they don’t know.
100 out of 1.5 Crore. You can do the math.
For the question of, whether this incident could be a mistake - 50% of the responses said definitely not.
There could have been some illegal activities here. But there are also chances for a honest mistake here as well.
We do not have any proof to reject this saying that this could not be a mistake.
The reason for this exercise is, everything that we see and hear influences our decision making without our knowledge.
So when we make a decision, we should be aware whether we are making that decision from our opinions or from an influenced opinion.
Not sure how many of you have read Robert Cialdini’s “Influence”.
He has beautifully explained with many examples on how we get influenced without our knowledge.
If you have not read that yet, I highly recommend.
“Ok. Is Groww app safe or not? What is the judgement on that”, you might ask.
I am not a judge to give judgement. My goal here is to give guidance on how to think and what are all the factors that we need to consider for making a decision.
Not giving judgement. That is in your hands.
Using the facts infront of you, you have to form your own opinion and make a decision.
If you do not believe in the brokerages, open the account directly with the fund houses.
But do not assume that there is no chance for them to make a mistake.
Mistakes can happen anywhere. But how they handle their mistakes is what builds the trust on us.
We will soon meet again in another episode. Thank You.