What happens when you start your Equity SIP and the market crashes?

As markets continue to rally, which in fact is good news for all Equity SIP investors, this also brings along with it some lingering concerns.

• I was planning to start a new SIP. But the markets have already rallied. I think I will wait for a few months before starting my SIP.

• Markets are close to their all time highs. My SIP investments have done well. Should I stop my SIP investments for the time being and start at a later point?

All these questions deep down are rooted in a perennial fear that all of us have –

“What if I invest now and the market falls?”

While this is a genuine pain point for lumpsum investors, Equity SIP investors already have this sorted! 

How?

Even if equity markets fall immediately after you start your SIP, you will still end up making good returns over longer time horizons!

Sounds gimmicky. I know. But let us explore the logic behind this.

Equity SIPs work better when there are temporary declines

Equity Markets as evidenced by history, go up in the long term, mirroring the underlying profit growth of businesses. But, in all likelihood, there will be several temporary declines along the way.

Through an SIP, we consistently buy units in a fund every month irrespective of the market conditions. Whenever there is a temporary market decline, the SIP buys us more units and vice versa. 

For example, if you are doing an SIP for Rs. 10,000 in Sensex, you will get approximately 0.20 units at the current levels of 50,000. If the index rises up to 60,000 by next month, you will get 0.17 units. But instead if the index falls down to Rs. 40,000, the SIP amount will buy you 0.25 units.

You end up accumulating more units when the markets are falling and less units when the markets are rising. 

Over a longer time frame, more market falls imply more opportunities to accumulate equities at a lower cost.

Ironically, if you think about it, temporary market falls are the real reason why Equity SIPs work well in the long run. The more the temporary falls in the interim the better!

Ahem! Ahem! This is too much of the same gyaan that you keep hearing. I get it.

So instead, let us see some actual evidence on what happens when your worst nightmare comes true – You start an SIP and the market has a large fall after that!

What if you had started an SIP in Sensex TRI right before the two worst market crashes (> 50% fall) in history – Dotcom Bubble in 2000 and Global Financial Crisis in 2008?

What if you had started your Equity SIP just before the Dot Com Bubble in 2000?

An SIP started on 11-Feb-00 just before the Dotcom bubble burst did not fare well in the short term (0 to 3 years). Of course, nothing to be surprised.

But here comes the surprise – the 5Y SIP returns were a whopping 23% (compounded annualized returns)!

As seen above, the Equity SIP performance eventually improved when markets recovered and the investment went on to deliver phenomenal returns – 34% CAGR over 7 years and 21% CAGR over 10 years.

What if you had started your Equity SIP just before the Global Financial Crisis in 2008?

The same is true for the SIP started just before the Global Financial Crisis. While the near term performance was impacted, the 3Y SIP returns were a whopping 23% (compounded annualized returns)!

The same SIP went on to deliver 15% in the next 7 years and 13% in the next 10 years.

What about Equity SIPs started before other major declines?

The same pattern has repeated for all Equity SIPs started before declines of more than 20% in the last 20 years.

There are few instances when the annualized returns dipped below 10% in the longer run because the portfolio met with the next crash. During such occurrences, extending the investment time frame by 1 to 2 years, led to significant recovery in returns.

For example, the 5-year annualized returns of an SIP started in Jan-04 was just 3% because the markets were down in Jan-09 due to the Global Financial Crisis. But when the time frame was extended by one year, the annualized returns jumped up to 22%.

Summing it up

While Equity SIPs cannot shield your portfolio from market volatility, it takes advantage of the occasional temporary market falls by accumulating more units when the prices have declined. Eventually when the performance of the underlying index or the fund starts to recover, the Equity SIP performance improves significantly.

Historically, when markets fell by more than 20%, it took around 1-3 years for the markets to go through a fall and make a recovery on average. Therefore, the Equity SIP returns in the short term are likely to be disappointing if there is a decline. But the decline helps your Equity SIP to accumulate more units at lower cost and the subsequent recovery leads to considerable gains on those units. 

While no one can predict exactly when the next market crash will happen, the best part about an Equity SIP is that if continued regularly and held for longer time frames, you are likely to have decent returns despite intermittent temporary market falls.

As seen from the past, even when started just before a large market crash, Equity SIPs have delivered respectable returns over the long run.

So if you are someone still in a dilemma about when to start your Equity SIPs – by now hopefully you should have the answer 🙂