SIPs average out costs and give better returns than lump sum during volatile periods
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Why SIP Is Best

SIPs underperform in a consistently rising market as its main advantage of cost averaging is not realised in such a case.

  • October 7, 2015  
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A thumb rule of investment is that one must not take too much risk. One way of ensuring this is systematic investment plans (SIPs), in which a person can invest in a disciplined manner at regular intervals without being too adventurous.

"In volatile markets, it is always good to go on a SIP mode as it helps one get the benefit of cost averaging over time," says Anil Rego, CEO & Founder, Right Horizons. As markets keep rising and falling all the time, the cost of buying units is averaged out over time as the investor gets more units when markets are down.

"Even when a client wants to invest a lump sum, we advise him to enter a debt fund first and do systemic transfer to equity funds. This helps him manage volatility and earn optimal returns," he adds. SIP can be monthly, quarterly or half-yearly.

BENEFITS OF SIP

Riding through volatility: If you are among those who are nervous about investing in equity funds because of market ups and downs, SIP will work best for you. It not only minimises the risk of losses due to fall in equity markets but also saves you the hassle of timing the markets, that is, investing when they are trading lower and exiting when they are rising.

In the last five years, the broader market, the BSE Sensex, has moved from 18,000 levels to 26,000, albeit with huge volatility. Now, let us assume you invested Rs10,000 every month into an Index Exchange Traded Fund (ETF) between September 2010 and September 2015. Your investment of Rs6 lakh would have grown to Rs8.04 lakh today with 11 per cent compounded annual growth rate (CAGR). The lump sum investment would have grown at eight per cent CAGR. The higher SIP return is due to the fact that you bought at various levels, both when the market was rising as well as when it was falling, averaging your cost. The average SIP return of large-cap diversified equity funds during the period was 14 per cent. Diversified equity funds are actively managed and, hence, are able to deliver superior returns.

"We recommend SIP to retail investors whose time frame is less than 10 years to avoid ill-timing the market. This is because there have been instances of negative point-to-point returns over seven to eight years (albeit temporarily)," says Srikanth Meenakshi, founder and COO, FundsIndia.com.

SIPs thrive on volatility: As volatility increases, the divergence between SIP and lump sum returns widens. For instance, the same amount of Rs10,000 invested in a SIP of a mid-cap fund would have delivered a return of 26.44 per cent; the lump sum return would have been 18.06 per cent. This is because mid-cap funds are affected by considerable volatility in stocks they hold, especially in a downturn. Hence, investors are likely to benefit more if they invest via SIP in these funds. Having said that, one must invest in a fund based on one's risk profi le and investment objective. Aashish Somaiyaa, CEO, Motilal Oswal AMC, recommends that investors should have one or two large cap and one or two mid-cap funds (for higher returns) in their portfolio.

Power of compounding: A SIP allows you to gain from the power of compounding if you are investing for goals that are some years away. An amount of Rs10,000 invested every month for 10 years will grow to Rs23 lakh at a modest CAGR of 12 per cent. Everyone has fi nancial goals such as buying a house or car, children's marriage and education and building a retirement corpus. You can allocate different amounts towards these based on the time you have for meeting these goals. If you want to invest for your retirement, go for an equity fund. Invest in equities for any goal which is five to seven years away, says Gaurav Mashruwala, Certified Financial Planner. For your child's education, go for a large-cap fund or an index fund. If the goal is immediate, such as buying a car or house, you can choose a less risky option such as a hybrid fund.

SIP ensures disciplined investing: There will always be times when the urge to splurge is high. This makes it difficult to contribute towards creation of a large corpus over a long period. SIPs enable you to do this by the discipline they impose. Since the amount gets invested automatically at fi xed intervals, the chances of you continuing the investment for a long period are higher.

Meenakshi of FundsIndia.com says while designing a SIP portfolio, one must fi rst decide the allocation, that is, how much money will go into what type of funds. Focus on three types - large-cap, small/mid-cap funds and debt funds. "A typical allocation should be 50 per cent in large cap funds, 20-30 per cent in small-mid/cap funds and the rest in debt funds," he says.

"Second, decide the number of schemes in your portfolio. Given that we have three prime asset classes, the portfolio should have at least three schemes," he says. An ideal number is five - four equity and one debt. Thereafter, one should choose the schemes based on the advice of the financial planner or after research that takes into account risk-adjusted returns over a period.

Fund houses are now offering several variants of SIPs for convenience of investors.

Systematic Transfer Plan:
Under STP, a person puts a lump sum in one scheme (usually a fixed income fund such as a liquid fund) and regularly transfers a fi xed amount into another scheme (usually an equity fund) every month on a specifi ed date. The idea is that if you have a large surplus, you must invest in equities in a staggered so that the volatility risk in minimised.

Flexi-SIP/STP:
Under SIP, one usually invests a fi xed amount every month or quarter. This is ideal for investors who earn a fixed income every month. However, for those with no fixed income, investing a specified amount every month may not be possible. Such investors can opt for flexi-SIPs, which offer flexibility of investing any amount within a range (say Rs1,000-10,000). The investor has to issue an ECS mandate for the maximum amount, which can be as high as 10 times the minimum amount. A flexible STP option is also available. It allows you to transfer a variable amount from one play to another periodically.

Value averaging plan: Under VIP, the investor sets a target for monthly growth and adjusts the invested amount according to the performance of his fund. Take a person who invests Rs5,000 in a fund and sets a 12 per cent growth target every year. Therefore, he expects his fund to return one per cent every month. This means his investment should become Rs5,050 by the end of the one-month period. However, if his investment grows only to Rs5,025, next month he will increase the amount to Rs5,025. If it grows by Rs`100 to Rs5,100, he will invest only Rs4,900 instead of Rs5,000. This means the person deploys more money when markets are down and less when they are up. Hence, he buys more units on dips. "However, the downside is that your savings rate remains volatile," says Meenakshi. Hence, it is important to ensure that the minimum investment under VIP is sufficient for the goal.

Step Up SIP: Your needs could change depending on your age, income, personal circumstances and lifestyle. The step-up facility is different from a simple SIP in that it allows you to start with a small monthly investment in the initial years. The amount goes up as and when your income rises.

DOES SIP ALWAYS WORK?

SIPs underperform in a consistently rising market as its main advantage of cost averaging is not realised in such a case. You end up investing at higher prices and keep getting fewer units. Take the period from 2004 to 2008, when the Nifty moved up from 2,000 to 6,000 levels. During this period, had you invested Rs5,000 a month from January 2004 until December 2007 (before the financial meltdown), your investment would have been worth Rs5.75 lakh until then.

In comparison, if you had invested Rs2.4 lakh (Rs5,000x48 months) as a lump sum in January 2004, your money would have grown to Rs7.8 lakh. Subsequent events, however, would have negated all the gains. In 2008, the Nifty fell from 6,000-odd levels to 2,500. Anyone who invested a lump sum would have had all his gains wiped out in a single year. Somaiyaa says investors can enter the market even with lump-sum allocations at the current juncture. "Anytime is a good time to start a SIP, but when you see a 15-20 per cent correction for reasons which have nothing to do with our country directly, I'd say it's time to GULP," he says.