Timing the market or time spent in the market?

According to the data from the Association of Mutual Funds in India (AMFI), the total assets under management (AUM) of the mutual fund industry has surpassed Rs.14.90 trillion in 2016 which represents an 18% growth in assets over the previous year. Initially viewed as an investment opportunity exclusive to the financially savvy, around 4.89 crore investor accounts exist as of this year. The increase can be attributed to a growing financially secure middle class and investor education.

The increasing interest in mutual funds have raised many pertinent questions namely what fund to invest in and for how long? Even after deciding on the investment duration and identifying the right mutual fund, the main dilemma for investors is the strategy itself. Should they try to time the market or maintain a buy and hold strategy?

The right strategy

Both methods have their fair share of promoters and detractors, and data supporting both claims is available. Market timing is the process where investors buy units at a low price and sell it when the prices are high. However, this method requires a vast knowledge of financial markets, accurately predicting future movements and nerves of steel. There is no algorithm or perfect process to accurately time the market for the simple reason being the sheer number of variables in the economy.

On the other hand, buy and hold strategy requires investors to buy units and keep them for an extended duration of time preferably five years or longer. As they have already decided their portfolio and identified their goals, they usually do not involve themselves in daily tracking, often checking the monthly or quarterly statements and deciding whether to invest more or not.

Despite the complexity of timing the market, a large number of investors flock to this route. The chief reason being the reward of greater returns compared to an equalized SIP. While a great deal of luck is involved, there are some events investors watch out for to time the market.

One such event is price corrections. A ‘timer’ can wait for corrections and then decide to invest. This helps bring down the average cost and would mean higher returns. However, this would involve both anticipating a correction and deciding to buy after the correction. While many analysts can predict when the current trend is about to change depending on certain parameters, to predict them and then profit from these transactions can be impossible in many cases. Another question to ponder over is what the right amount of correction is? 5%, 10% or maybe 20%. This would depend on the stock and the investor.

The downside to time the market is the withdrawal of money at uncertain intervals which is invested again at an unknown time. Contrast this with an equalized SIP where you have a steady corpus building up with compounding.

Tax efficient

The buy and hold strategy is also more tax efficient. Taxation comes into the picture when the investor is ready to cash out and with a long term SIP, the capital gains tax is virtually none. However, a “timer” will end up withdrawing their investments and have the very real possibility of paying short-term capital gains tax. And in India, short-term capital gains are the same as the highest tax bracket which is at 30%.

The Bottom Line

According to A Balasubramanian, CEO, Birla Sun Life AMC, trying to time the market is impossible. He says,” (Market) volatility is something which you cannot escape. It is more important to spend time in the market rather than timing the market.”

The right way would be a slight mix of both. Don’t throw caution to the wind when it comes to market movements. Stay updated and informed. If there is a price correction, one can choose to invest more depending on the risk capacity of the individual. When it comes to timing, there is a greater risk of losing out on the upswing. While it may be possible to boost returns with perfect timing, there is no clear, systematic approach.