Should you time the market before investing?

The answer is yes. But, timing the market is the most confusing thing all investors talk about. What do we really need to time? NIFTY closed at 11500 today means nothing and tell us nothing. And those weird graphs make us feel dizzy in the head. So, we’ve figured out a way to help you time the market in the simplest way possible.

It’s always better to have quantitative parameters to determine the market levels. The most commonly used is PE ratio (Price to Earnings ratio). So to understand this, let’s use the PE levels of NIFTY 50 index.

The easiest way to think about NIFTY PE is a higher PE indicates that markets are expensive and the lower PE indicates that markets are relatively cheap. Simple, right? Now that we have parameters to gauge market levels, let’s figure out the right time to invest in mutual funds.

Here’s the annualised returns at different PE levels. It’s based on NIFTY index data for last 20 years.

If you invested in NIFTY index on the days when PE was greater than 24 and held it for 5 years, then your average return would have been 2.5%. And in the worst case, people have ended with a negative 1%.

Now, if you invested on the days when PE was between 14 to 17 and held it for 10 years, your average return would have been 16.1% and in the worst case would have been 9.6%.

Simple. If you invest when the PE ratio is high, you would end up with lower returns. And when the PE ratio is low, the returns are relatively higher. So, to answer your question, it is important to time the marker when investing a lump sum amount.

How about SIP’s?

When you start an SIP, you invest a certain amount every month. Suppose you invest for 5 years. So, even if you start at a relatively higher PE, chances are for 5 years you would invest at different PE levels – some at higher, some at lower.

So, despite this simple process of timing the market, if you still find it too complicated, start an SIP. Because an SIP provides a classic cost averaging, which means all your 60 instalments will most likely be invested at different PE levels, providing decent returns.

Here’s what we learnt from this. It is important to time the market before investing a lump sum amount in mutual funds and there is an easy way to do it. But, if you want to start an SIP, you just wasted your 10 minutes reading about timing the markets.

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*Mutual fund investments are subject to market risks, read all scheme related documents carefully.

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