Is it the right time to top up your investment? An analysis of market timing

This article is authored by Sonam Srivastava, founder and CEO of Wright Research.

The market has been on a rollercoaster ride lately! Whether it's the volatility and scepticism before the Indian elections in 2024 or the recent global macro data delaying the prospect of a rate hike. Many investors are wondering: should I add more money to my investments right now?

Top-up investing, the strategy of regularly adding funds to your existing investments, is a popular way to build wealth over the long term. But with the current market fluctuations, the question of when to top up becomes even more critical.

The truth is, there's no single "perfect" answer. The market can be unpredictable, and attempting to time major swings (buying low and selling high) is notoriously difficult. However, our analysis offers interesting insights that can guide your top-up decisions.

So, we did a little experiment for you. We looked at historical data for the Nifty 50, Nifty Midcap 100, and Nifty Smallcap 100 indices since 2014. We compared the performance of a simple buy-and-hold approach with various market-timing strategies:

• Buying during corrections: Adding money only when the index experiences a price decline in the previous month
• Buying during rises: Investing only when the index experiences a price increase in the previous month

The results are intriguing. Here's a sneak peek:

• Market timing can potentially lead to slightly higher returns. Compared to simply buying and holding, some correction-based strategies yielded a modest increase in XIRR
• Significant corrections and rises offer the highest potential gains but with a catch. Strategies that were bought during major corrections (10 per cent or 15 per cent decline) or significant rises (10 per cent or 15 per cent increase) achieved the best results. However, these strategies involved very few trades, making them difficult to replicate consistently.
• Monthly SIP offers a disciplined approach. Regularly investing a fixed amount, regardless of market conditions, can be a more practical option for long-term wealth creation.

This data highlights the potential benefits of market timing, but also its limitations. In the next section, we'll delve deeper into these findings and explore factors to consider when deciding on your top-up strategy. We'll also discuss the importance of a long-term investment horizon and the role of a financial advisor in helping you make informed decisions.

Time in the Market vs Timing the Market

One of the most enduring debates in investment strategy revolves around the merit of "time in the market" versus "timing the market." Many novice investors are tempted to time the market — that is, to buy low and sell high based on predictions of market movements. While the concept sounds appealing, it requires predicting market peaks and troughs, a feat not even the most seasoned investors can claim to perform consistently and successfully.

The alternative, and often more effective strategy, is to spend more time in the market. This approach advocates for maintaining your investment over a long period, thus weathering the inevitable ups and downs. The logic here is rooted in the power of compounding — the financial principle that profits, as they are reinvested, generate their own profits over time. Historically, long-term investments have shown a tendency to yield robust returns despite short-term volatility.

The Peril of Missing the Best Days

Our analysis of the Nifty 50 since 2014 shows a stark reality: missing even a handful of the best-performing days can significantly impact your returns. Consider this: a simple buy-and-hold strategy yielded a Compound Annual Growth Rate (CAGR) of 13.08 per cent. However, if you missed the top 20 best days, your CAGR drops to a mere 4.78 per cent. That's a difference of over 8 per cent annually! That's a difference of over 8 per cent annually! This highlights the power of compounding and the significant contribution of those high-growth days.

Thus, while the allure of timing the market for quick gains is strong, the statistical and historical evidence leans heavily towards the benefits of time in the market. For most investors, particularly those looking at retirement or other long-term goals, being consistent is more lucrative than being occasionally right.

Data-Driven Insights on Top-Ups

While a buy-and-hold approach with regular top-ups is a well-established strategy, investors are always curious if there are optimal times to add more to their portfolios. Our research delves deeper by exploring various top-up strategies for the Nifty 50, Midcap 100, and Smallcap 100 indices since 2014. Here's what we discovered:

Top-Up Experiments and Potential Advantages:

We compared the performance of a simple buy-and-hold approach (investing regularly in an index fund) with various market-timing strategies:

Buying During Corrections: We analysed scenarios where investments were made only when the index experienced a price decline in the previous month (5, 10, or 15 per cent).

Buying During Rises: We also explored scenarios where investments were made only when the index experienced a price increase in the previous month (5, 10, or 15 per cent).

The results were intriguing. Here's a breakdown for each index:

• Nifty 50: Compared to the buy-and-hold CAGR of 13.08 per cent, some correction-based strategies yielded a slightly higher return. For example, buying only during 10 per cent corrections resulted in a CAGR of 15.78 per cent, but with fewer trades. This suggests that strategic buying during downturns may offer some benefit, but catching major corrections consistently can be challenging.

• Nifty Midcap 100: The data showed similar trends. Here, a strategy that bought during 15% corrections achieved a CAGR of 23.04 per cent compared to the benchmark's 19.84 per cent. However, this involved very few trades, highlighting the difficulty of replicating such timing.

• Nifty Smallcap 100: Interestingly, the Smallcap 100 data suggested that buying during moderate rises (10 per cent) might have offered the best return among rise-based strategies (CAGR of 23.44 per cent) compared to the benchmark's 19.84 per cent. This finding deviates slightly from the other indices, possibly reflecting the higher volatility associated with smaller companies.

Incorporating Market Cycles and Economic Indicators

While these experiments show a potential benefit to some level of market timing, it's crucial to consider broader factors:

• Market Cycles: Understanding where the market is in its cycle (bullish, bearish, or corrective) can inform your top-up strategy. Buying during corrections might be more advantageous in a downtrend while increasing top-up amounts during periods of relative stability might be suitable for shorter time horizons.
• Economic Indicators: Economic indicators like inflation rates, interest rates, and GDP growth forecasts can offer clues about potential market turns. Consulting a financial advisor can help you interpret these indicators and tailor your top-up strategy accordingly. For instance, if rising inflation is expected, you might consider increasing investments in inflation-hedged assets during your next top-up.

Tailoring Top-Ups to Your Investment Goals

The optimal top-up strategy also depends heavily on your investment goals and risk tolerance :

• Long-Term Goals: For long-term goals (retirement in 20+ years), a disciplined approach like a monthly SIP (Systematic Investment Plan) is often recommended. This allows you to benefit from rupee-cost averaging and avoids the pressure of market timing.
• Short-Term Goals: For shorter investment horizons (down payment in 5 years), a more cautious approach might be suitable. You could consider increasing top-up amounts during periods of market stability, but remember that attempting to time the market perfectly can be risky.

Navigating the Indian Market

The Indian economy stands at a crossroads. While global headwinds like slowing growth in the US, rising inflation pressures worldwide, and delayed interest rate hikes by the US Fed create uncertainty, India's domestic fundamentals paint a cautiously optimistic picture. Here's a breakdown of key factors influencing investment decisions:

Macroeconomic Landscape - A Mixed Bag:

• Global Cues: Slowing growth in major economies like the US and the ongoing war in Ukraine are casting a shadow on the global economic outlook. Additionally, rising inflation across the globe is putting pressure on central banks to raise interest rates, impacting investor sentiment and potentially leading to market volatility.

• India's Strong Growth: However, India's economy is showing signs of resilience. The World Bank has revised India's GDP growth forecast for FY23 - 24 to 6.3 per cent, indicating continued expansion. This is backed by strong domestic consumption, particularly among higher-income earners, and a robust services sector. 

Interest Rates

• The Fed Rate Hike Delay: The US FED is expected to delay interest rate cuts till September after seeing the dismal growth data and a hike in inflation. The US yields have spiked and put a damper on the market mood with some even hinting at potential stagflation.
• The RBI's Balancing Act: The Reserve Bank of India (RBI) is walking a tightrope. While inflation remains a concern, and global cues are also a worry, the central bank is likely to keep interest rates steady cautiously to balance controlling inflation with supporting economic growth. This measured approach can be positive for investors seeking stability.

Corporate Earnings - A Sectoral Viewpoint:

The earnings for the fourth quarter of FY24 were not expected to be exemplary, in fact, analysts were expecting a slowdown due to high rates and global headwinds. The results released till now have been varied but not disappointing in terms of expectations.

Starting from the IT Sector, TCS posted healthy growth and strong deal flow, reflecting strong demand for digital transformation services globally. Infosys results also had a silver lining of rising deal flow.

Among the financial sector, ICICI Bank wowed analysts with exceptional returns and robust loan growth, indicating a pick-up in economic activity. Axis Bank also posted strong numbers. Among Financials - Bajaj Finance disappointed with concerns over profit growth and shares tumbled as the company forecasted its assets under management to grow between 26 per cent and 28 per cent in the fiscal year that started April 1, 2024, compared with 34 per cent growth in the previous year.

Among FMCG stocks Nestle posted good numbers but still saw price drops as rural demand remains under pressure. HUL also saw price pressure after a decline in profits and commodity price concerns,

Stocks like Vedanta in the Metals segment shone through despite a decline in profits as the prospects remained strong and the stock met expectations.

While many more results are still awaited, the Q4 earnings have been an interesting mixed bag with many positive surprises and optimistic management commentary.

A Cautiously Optimistic Outlook

The Indian market presents a complex picture. While global uncertainties and rising interest rates pose challenges, India's strong domestic growth story offers reasons for optimism. By staying informed about economic data, corporate earnings, and market trends, investors can develop a well-rounded strategy.

Making Your Top-Up Decision

The insights gleaned from market data, earnings reports, and broader economic factors paint a valuable picture, but ultimately, your top-up decision needs to be tailored to your unique circumstances. Here are some key considerations to keep in mind:

Individual Investment Goals

• Are you saving for retirement in 20+ years? You might prioritise a disciplined approach like a monthly SIP (Systematic Investment Plan) to benefit from rupee-cost averaging and avoid the pressure of market timing.
• Do you have a shorter investment horizon, like a down payment in 5 years? A more cautious approach might be suitable, with the potential for increasing top-up amounts during periods of relative market stability.

Risk Tolerance

• Are you comfortable with some level of market volatility in exchange for potentially higher returns? If so, you might consider incorporating a market-timing element into your top-up strategy, focusing on buying during corrections or rises as discussed earlier.
• Do you prefer a more conservative approach focused on capital preservation? Regular, smaller top-ups might be more suitable, potentially focusing on less volatile sectors or fixed-income instruments.

Investment Timeline

• Long-term investors have the advantage of time to ride out market fluctuations. A disciplined, diversified approach is often recommended for long-term goals.
• Short-term investors need to be more cautious and may prioritise investments with lower risk profiles.

Conclusion: Investing in the Long Haul

The quest for optimal top-up strategies can be tempting, but remember, the journey matters more than the destination. Here are the key takeaways to keep in mind:

• Time in the Market is Kinnng: While market timing strategies might offer some potential benefits, staying invested for the long term is often the most effective approach. The power of compounding works best when you give your investments time to grow.
• Data-Driven Decisions: Market data, earnings reports, and economic indicators offer valuable insights. Utilise this information to inform your investment strategy, but remember it's not a crystal ball.
• Current Conditions Shape Your Approach: Global headwinds, rising interest rates, and strong domestic growth in India create a complex picture. Consider these factors when making top-up decisions, but don't let them paralyse you.

Investing is a personal journey. Your investment goals, risk tolerance, and investment timeline shape your strategy. Utilise the information presented here, conduct your own research, and don't hesitate to consult a financial advisor for personalised guidance. By making informed decisions based on your unique circumstances, you can navigate the market with confidence and work towards achieving your financial goals.

Disclaimer: The opinions expressed above are personal and may not reflect the views of DSIJ.