All of us are more affected by losses than equivalent gains on an investment. This phenomenon is termed as Loss Aversion – the underlying research won a Nobel prize in 2002. As markets are unpredictable and volatile in the near term, our Loss Aversion bias sometimes creates a fear of incurring losses and prevents us from making long-term investments when we receive a large lumpsum amount such as an annual bonus.
If we believe that the stock market in general goes up over the long term and we can take a 10-15 year view, it should be an obvious decision to invest your lumpsum in equity mutual funds or stocks. However, what stops many of us is the fear that we may lose money in the short-term. To invest lumpsum amounts in the market, we need some mental tricks to manage this fear.
One way to do this is through an STP or a Systematic Transfer Plan. First you invest your lumpsum amount in a short-term debt mutual fund and then set up a systematic (meaning regular) transfer to an equity mutual fund (it would need to be in the same AMC) over the next 1-2 years. This strategy helps you enter the market at an average cost over the next 1-2 years rather than today’s price. It helps you avoid regret in case the market dips immediately after you invest your lumpsum.
Does such a strategy always work? While it provides mental comfort, our analysis over the last 15 years showed that lumpsum investments outperformed an STP-based strategy 60-70% of the time. It may still be the right solution if it gets you to invest, rather than waiting for the perfect time and never doing it.
Another such mental trick is to invest the money and ‘hide’ its performance by not tracking it for a long time – usually you will find later that it has done well and your fears were unfounded. This is also why products with lock-in such as ELSS deliver better results for investors than regular equity mutual funds, though both may own the same underlying stocks.
Yet another solution is to invest your lumpsum in a well-researched diversified multi-asset portfolio and rebalance regularly with the help of an expert – over the long term, the rebalancing will reduce downside volatility significantly and help you avoid large losses.
