Monday, June 24, 2024

The growing pains of retail investors: Do they truly exhibit maturity?

In fact, cliches don’t just thrive on sports pages or in political speeches, they are employed even by those in the business of selling stocks, directly or indirectly, to retail investors. A cliché that has thrived in recent years is that the Indian retail investor, who invests in stocks indirectly through the mutual fund (MF) route, has really matured.

The rationale offered by those employed by the Indian MF industry is that in the last few years, the number of outstanding systematic investment plan (SIP) accounts has gone through the roof. The number stood at 62.8 million as of February, a jump of 136% since April 2019.

An SIP is a way of investing routinely in an MF, typically an equity fund, which then invests the money collected largely in listed stocks. Under an SIP, an investor commits to investing a certain amount of money regularly, usually every month, taking stock market timing out of the equation and bringing acquisition cost averaging into the picture.

When the stock market is doing well, the net asset value (NAV) of the MF is on the higher side. Given that a fixed amount of money is being invested through an SIP, this automatically limits the number of units of the MF being bought in the process.

When the stock market is not doing well, the NAV is on the lower side, which increases the number of units being bought. Hence, an SIP over a period of time ensures that investors buy more units when the market isn’t doing well and less when it is, driving up long-term returns through cost averaging. Now for the SIP strategy to succeed, the key is that the investor keeps investing for at least five years. This allows different stock-market cycles to play out, ensuring that cost averaging happens and drives down the average price of MF units bought and thereby driving up the return on investment. Given this, anyone investing in stocks through an SIP is deemed to be a mature investor.

But is this happening? In February, 2.1 million new SIP accounts were opened. Also, 1.4 million accounts were discontinued or their tenure was completed. This implies a stoppage ratio of 68% (accounts discontinued divided by accounts opened), the highest in 27 months.

In fact, a stoppage ratio of 68% implies that many investors have been discontinuing their SIPs. Hence, while the overall number of SIP investors has been going up as newer accounts keep getting added, at the same time many investors are dropping out. Given this, they’re really not gaining from the SIP strategy of investing for the long-term, implying that the idea of a maturing Indian retail investor has little to support it.

It is well documented that many retail investors tend to invest in stocks when prices are at their peak and slowly drop out as they are disappointed with the returns. This stands true for SIP investors as well. From April 2019 onwards, the stoppage ratio of SIPs was the lowest in October 2021, when it was at 36%. Further, in October 2021, the number of new demat accounts opened peaked at 3.5 million. A demat account is required to buy and sell stocks. Indeed, on 18 October 2021, the BSE Sensex had touched its then all-time high of 61,766 points, having jumped 138% in less than 19 months.

Hence, all this talk about the maturity of the retail investor is overdone, given that since October 2021, 18.2 million SIP accounts have been discontinued or their tenure has ended. Of course, 34.6 million new SIP accounts have been opened since then. It remains to be seen whether these new SIP accounts stay invested for the long-term and display the maturity required.

So, what does this tell us? Many retail investors, including SIP investors, end up investing around a point when the stock market is peaking, looking at stocks to make a quick buck.

There are several other unique factors at work when we consider the last few years. First, interest rates crashed, pushing investors towards stocks. Second, many investing apps offered incentives to lure investors. Third, many financial influencers got into the business of recommending stocks and MFs, attracting online audiences of retail investors.

In the last one year, these factors have weakened. Interest rates have gone up. Apps are no longer offering the kind of incentives that they were. And India’s market regulator has cracked down on financial influencers.

Finally, this lack of maturity in many retail investors is still in evidence, despite a good ad campaign launched by the Association of Mutual Funds in India, an MF industry lobby, which emphasized the importance of staying invested in equity MFs for the long-term. What all this tells us is that many retail investors really do not have the mental makeup to bear the ups and downs that come with investing in stocks, though they may want to earn a quick buck from it. As Klinkenborg put it, “A cliché is dead matter.” So is the game of trying to make a quick buck by investing indirectly in stocks through the SIP route.

Vivek Kaul is the author of Bad Money.

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