Investing in Mutual Fund SIPs

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One of the questions investors have been asking of late is whether it's time to discontinue their SIPs. A systematic investment plan, or SIP, has been a popular method of investing in equity funds. Likewise, funds have marketed this idea of disciplined investing successfully. The biggest merit of a SIP is that it allows one to invest regularly without being bogged down by questions about the right time to jump in. However, the past five years of lack lustre performance have led to a spate of SIP cancellations. Perhaps it is time to refresh your knowledge about SIP fundamentals.

 
To begin with, an SIP is not a product or a fund. It is simply an investment process. Instead of basing investment decisions on expectations of how the market will behave, SIPs facilitate a disciplined participation in the market through ups and downs. Since a fixed amount is invested across time, SIPs enable a reduction in average cost. Therefore, the returns from an SIP are not likely to be different from those of the mutual fund in which the investment is made. Many investors believe that if they invest through SIPs, they will earn better returns. That is not true. The returns will depend on how the fund has performed at all times.

Second, the benefit of this option has to be measured across cycles. If you invest via an SIP as the NAVs are moving up, then while computing your return, you will value all your SIPs at the current NAV, which would be higher than your cost of acquisition. Sure enough, your SIPs will look good. However, in a falling market, all your SIPs will be valued at the lower NAV, and hence, will look bad. The returns are measured on the basis of where you stand today, and that will bias your gain or loss. If you persist across cycles, your investment in both the equity and SIPs will look good.

Next, there is no point in comparing lump-sum investments and SIPs. I have seen strenuous research in recent times trying to establish when and under what conditions a SIP can beat lump-sum investment. Actually, they are two completely different ideas, and the latter will typically beat SIPs. When you invest a lump sum, a larger chunk of your money works for a longer period of time. On the other hand, a SIP is a slow model, where you build your wealth with each instalment. Had you invested 10,000 per month in the Sensex since its inception in 1979—406 months in all—you would have about 1.6 crore today. A lump-sum investment of the same amount, 4.06 lakh at that time would be worth over 8 crore today. If you have a lump sum handy, you are better off not trying to go for an SIP unless you think the market is falling and you want to invest at lower levels.

Fourth, SIPs are not about smart market timing; they simply allow you to invest regularly. Assume that you took a home loan and the bank gave you the option of paying only the interest as EMI and repaying the principal amount at maturity, say, after 15 years. Would you rejoice? Not really. You would obviously like to retire the debt using your monthly income. If you have to pay a lump sum on maturity, you might be forced to sell your house to make the payment. Who would want to be in such a situation? So, you choose the regular EMI route and repay the loan when you land a lump sum windfall. This is similar to the SIP route. You invest something every month when you can save, and when you have a lump sum handy, you put it to work too. SIPs enable you to be disciplined in your investing. Without one, you may not even have participated in the down market.

Fifth, when you cancel your SIP, you need to find a way to deploy the money you are saving. Even if you keep it idle in the bank, seeking a safe investment option, you have made a significant asset allocation decision. You have reduced your exposure to equity and increased it to cash. You have to ask yourself if this helps your long-term goals and wealth. Cancelling a SIP in a down market amounts to under weighing equity in a bear market. If you choose to come back when the market moves up again, you are invariably coming in at a higher NAV, and lose the benefit of having invested at the bottom. Your money moves with the market in a SIP, and when you leave
and join at will, you indulge in trying to time the market. When this attempt converts into buying at peaks and selling at the bottom, there is no money to be made.

Next, remember that an SIP in a debt fund is not a great idea, especially when you want to invest a lump sum. A debt fund earns steady and regular interest income. The lesser you participate, the lesser you earn. In equity, the market cycles may modify your benefits in the short term, but with a debt fund, holding a lump sum to invest, and then choosing a SIP is clearly inefficient. If you have the money, put it to work.

The problem, as I see it, is that we seem to have a cultural issue with process and discipline. SIPs are a simple and nice way of investing surplus money without having to do much work on it each time. Instead, we have started asking questions: how to make more out of a SIP, how to beat lump-sum investing, how to beat markets with SIP, how to take the SIP option in a falling/rising market. These are all exercises in futility. A SIP in equity will be subject to market volatility but will do well in the long run, just like any other equity investment. To cancel a SIP in a falling market is to take the timing call that you will not participate in a falling market.

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