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Investment - Needs A disciplined approach
Anyone wanting to plan effectively for retirement or any other long term financial goal recognizes the need to accomplish a series of key tasks which include identifying financial needs during retirement, saving an appropriate amount over time, selecting a portfolio of assets with a risk-return profile that is appropriate for reaching the retirement goal and having procedures in place to prevent those assets from being consumed too early .
Systematic investment plans (SIPs) in mutual funds inculcate a discipline in investment process that help one in financial planning. Investments through SIPs may not be a recipe for sure success but they do help to moderate investors' biases that they suffer and help them achieve their financial goals.
Here are some of the traits that are associated with SIPs:
SIPs are habitual and conventional: Regret is especially painful if the action that was taken is perceived as departing from what is habitual. But SIPs are habitual like making EMI payments on the first of every month. But lump sum investing is not routine and it appears to be less prudent than the cautious step-by-step approach of SIPs. SIPs mimic regular deposits in a defined contribution plan. It is an anti-panic device when markets fall.
SIPs inculcate a disciplined approach towards reaching a financial goal like retirement etc. However, psychological factors that prevent one to plan for future are: Myopia or short sightedness leading to low tolerance for risk, Overconfidence leading to overestimation of finances as investors seem pretty biased about having sufficient resources in place for their retirement. There are at least two different ways that myopia can plague investors saving for retirement. First is the insufficient attention to retirement as it seems to be far off. And the second one concerns investors' attitude towards facing risk. Often investors choose portfolios that are too conservative for the goals to which they aspire for. The disciplined approach of SIPs helps investors overcome these biases.
SIPs help to overcome loss aversion: SIPs help people to frame their investments as multi-round opportunities rather than each investment as a one-shot opportunity. A lottery is a one-shot opportunity .Study show about 40%of the people are willing to take risks with gamble but the percentage of people willing to play increases dramatically when they are offered to play the lottery is more number of times, say 100. Tolerance for risk increases as the number of repetitions of gamble goes up. This is because people evaluate one shot gamble in isolation from other decision problems and record the possible outcomes for each of these gambles in separate mental accounts.
SIPs help one to diversify across time: Mutual funds help one to diversify across assets and stocks, while SIPs in them help one to diversify across time. Investing smaller amounts in the form of multiple bets offer time diversification, where people may feel that they have law of averages by their side. The important element in time diversification is the ability to postpone, or avoid altogether the realization of a perceived loss. This is one of the reasons investors prefer fixed maturity plans or any other close ended schemes to open ended schemes. Investors of close ended schemes do not perceive loss as they hold their investments up to maturity and hence do not value it before maturity
SIPs help one to overcome empathy gaps in investing: The inability to predict our own business behaviour under emotional strain is called as an empathy gap. Everyone encounters empathy gaps. For instance, just after eating a large meal, one cannot imagine ever being hungry again. When asked in the cold light of day how we will behave in the future, we turn out to be very bad at imagining how we will act in the heat of the moment.
Celebrated investor John Templeton said "The time of maximum pessimism is the best time to buy , and the time of maximum optimism is the best time to sell". Few would disagree. However, when everyone is busy despondently selling, it can be hard to stand against the tide and buy . So SIPs force one to be committed to investment across various cycles of the market, be it bearish or bullish, and helps one to overcome these empathy gaps.
Finally, there is always a comfort of following the well laid path. To quote J M Keynes, "Worldly wisdom teaches us that it is better for reputation to fail conventionally than to succeed unconventionally ."
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