As Justyn Walsh writes in Investing with Keynes: “Keynes’ most famous example of the ‘fallacy of composition’ was the so-called Paradox of Thrift–which notes that saving is good for the individual, but if all individuals increase their savings then aggregate demand will fall, eventually leading to lower savings for the population as a whole.”
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How the stock market behaves at different points is another example of the fallacy. As Walsh writes: “The stock market… can, on occasions, display emergent properties, where individual behaviour mutates into mob irrationality.” So, it might make sense for an investor to buy stocks at a given point of time, but if too many investors start doing so, then prices go up too soon too fast, weakening their correlation with company earnings.
In India’s case, much of the stock market rally between April 2021 and September 2024, when prices peaked, was driven by retail investors, particularly those investing in equity mutual funds (MFs) through the systematic investment plan (SIP) route.
Between April 2021 and September 2024, the Nifty-500 total returns index (TRI) more than doubled. ‘Total’ here means the index takes company dividends into account while calculating returns. During the same period, the Nifty MidSmallCap 400 TRI gave a return of more than 160%.
In 2020-21, foreign institutional investors (FIIs) had heavily bought Indian stocks, worth ₹2.74 trillion, at low valuations. But from April 2021 to September 2024, they bought shares worth only ₹1.2 trillion. During the same period, ₹6.1 trillion was invested in MFs through the SIP route.
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Now, all this money would not have gone into equity MFs. Estimates suggest that around 90% of money invested through SIPs goes into equity MFs, and that works out to ₹5.5 trillion. Indeed, that’s the kind of money that must have been invested in equity MFs through SIPs, of which a large amount would have been in Indian stocks. So, it’s safe to say that money from SIP investors was a major force driving up the stock market after 2020-21.
SIPs as a way of investing make sense at an individual level and can create real wealth over time. But post-2020-21, the fallacy of composition struck.
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The interesting thing is that investing in SIPs, unlike retail interest in stocks and their derivatives, took off before the pandemic started. In 2016-17, the total money invested in MFs through SIPs was ₹43,921 crore. This jumped to ₹67,190 crore, ₹92,693 crore and ₹1,00,084 crore in 2017-18, 2018-19 and 2019-20, respectively.
What changed? In March 2017, the Securities and Exchange Board of India allowed MFs to use celebrity endorsers. The Association of Mutual Funds in India enrolled Sachin Tendulkar, Mahindra Singh Dhoni and Rohit Sharma for its “Mutual fund sahi hai” (‘MFs are right’) campaign. Tendulkar appealed to those who grew up in the 1990s, Dhoni to those in the 2000s and Sharma to those in 2010s, thus making SIPs widely popular across the country.
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After the covid market crash of March 2020, indices rallied big time for the next few years, drawing many more retail investors to invest in stocks through SIPs. This was mostly what pushed prices beyond what their current and future earnings justified.
So, the individual rationality of investing in stocks through SIPs led to the aggregate irrationality of making Indian stocks overvalued. As Charles Kindleberger writes in Manias, Panics and Crashes: “The action of each individual is rational–or would be if many other individuals did not behave in the same way.”
From 26 September to the end of February, India’s stock market has fallen sharply. The Nifty 500 TRI and MidSmallCap 400 TRI have dropped 18.6% and 22%, respectively. Yet, SIP inflows remain strong, with more than ₹1 trillion coming in between October and January. This, during a phase when FIIs net sold Indian stocks worth ₹1.8 trillion. Without SIP money, prices would have fallen further.
Nonetheless, the SIP stoppage ratio in January stood at 109%, implying that for every 100 new SIPs opened, 109 SIPs completed their tenures or were discontinued. This ratio is the highest since April 2021, the month since when this data is available.
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It implies that many investors are stopping their SIP flows into equity MFs after having bought stocks at peak prices. Those who have quit investing now that prices are falling are also taking cost averaging, which is at the heart of SIP investing, out of the equation.
In January 2025, India’s total SIP accounts stood at 102.7 million, a tad lower than 103.2 million in December 2024. This marks the first month-on-month decline since the availability of this data.
To conclude, the fallacy of composition has put SIP investors in a really weird situation. But they are probably better off continuing with their SIPs than discontinuing them.
The author is the author of ‘Bad Money’.