Many retail investors have started taking SIP route to investing in equity mutual funds. Even in the recent market fall, most continued with their SIPs. This is a good trend. For success in equity markets, you need investment discipline. And SIPs help you maintain that discipline.
However, I feel investors have become too optimistic. Investing through SIPs is fine but they have started to ignore risks that are inherent with equity investments.
The credit goes to investor awareness programs (limited impact) and media and marketing blitz by the Asset management companies (AMCs). Investors who were scared of taking exposure to equity markets have begun to feel that you cannot lose money in equity markets if you invest through SIPs. Essentially, they have gone to the other extreme.
Is this right? I don’t think so.
I do not deny SIP is the best way to invest in equity mutual funds for retail investors. However, that does not mean you cannot go wrong with SIP.
In this post, I will discuss a few misconceptions investors have about Systematic investment plans. To start with, let’s first see what Systematic Investment Plans (SIP) is.
What is a Systematic Investment Plan?
It is a way to invest in mutual funds. When you start a SIP, you allow the AMC (mutual fund house) to auto-debit your bank account on a particular date every month and use the amount to purchase mutual fund units. And that’s it. SIP is nothing more than that.
SIPs help in rupee cost averaging. Suppose you invest Rs 10,000 per month in SIPs. In a particular month, suppose NAV is Rs 100 per unit, you will get 100 MF units. Next month, it is 125; you will get 80 MF units. In the third month, it is 80, you will get 125 units. In the fourth month, it is 75, you will 133.33 units. In the fifth month, NAV is 120 units, you will get 83.33 units.
At the end of 5 months, you have invested Rs 50,000 and got 521.7 MF units at an average price of Rs 95.84. So, even though the price ranged from 75 to 125, your average price is Rs 95.84.
For you to make money on this investment, the NAV of MF unit (at the time of sale) must be greater than Rs 95.84.
I have shown the SIP for just 5 months. You can run the SIP for years. For you to make profit, the average selling price should be greater than average cost price. Simple.
SIPs help you save the futile effort of timing the market. Anyways, not many can time the market.
SIPs lead to inertia. You have set up ECS mandates. Money gets automatically debited and gets invested. You don’t have to go through emotions and bear with market noise. One of the few cases where inertia can help.
Must Read: How SIPs make long term investing easier?
Now, let’s look at some of the misconceptions.
Myth 1: You cannot lose money if you invest through SIPs.
SIP is no magic wand. It is not guaranteed that you will get good returns in SIPs. You may even incur losses.
As mentioned in the previous section, for you to make money, average selling price has to be greater than average cost price. And that is the underlying premise.
The underlying premise about success of SIP in equity mutual funds is that the equity markets will do well over the long term. Suppose you invest in an index fund (that replicates the Nifty performance perfectly). You invest Rs 10,000 every month in SIP for 5 years. The average purchase level of Nifty is say 8500. For you to make money, Nifty should be above 8500 at the time of sale. If it is less than 8,500, you will incur a loss.
If the Indian equity markets perform badly over the long term, your SIPs will also fare badly.
Myth 2: SIP is an investment
I get a number of queries such as “I want to invest in a SIP. What should I do?” You cannot expect this question from someone who understands mutual funds. Again, the credit goes to the marketing teams of AMCs. Many new investors (with little knowledge of MF investments) have begun to feel that SIP is a wealth creation tool that cannot miss. So, they want to ride SIP bandwagon and want to invest in SIPs.
SIP is not an investment per se. SIP is merely a way to invest in mutual funds. And it is not the only way. You can make lump sum investments.
In fact, you can even invest systematically without taking the SIP route.
Rather than giving AMC the mandate to debit Rs 10,000 from your bank account to invest in a particular MF scheme on say 15th of every month, you can go to AMC website (or any other MF portal) on 15th of every month and invest Rs 10,000 in the scheme.
Myth 3: Investing through SIP reduces your risk
Completely untrue. With SIP, you merely avoid the risk of investing at very high market level. On the other hand, you also let go of the opportunity of investing at a potentially low level. So, it can work both ways. Well, no one has the gift of hindsight.
Volatility inherent with equity markets and the risk of loss is still there. It does not change just because you are investing through SIP.
Investment through SIP does not reduce market volatility for you. You invested Rs 10,000 per month for five years at average cost price of Rs 92 per unit. Somehow, I happened to invest Rs 6 lacs on a day when NAV was Rs 92. Both of us have invested Rs 6 lacs and the average price is Rs 92.
If we leave out the tax implications, aren’t both of us subject to same volatility and risk of loss?
Myth 3: You must use SIP to invest in any kind of mutual funds
SIPs are well suited for investment in equity mutual funds. This is because equity markets can be quite volatile in the short term. For investment in debt mutual funds, you are better off investing lump sum in most cases.
If you have Rs 10 lacs that you want to invest in a liquid fund or an ultra short term debt fund, you are better off investing lump sum. If you are talking about long duration debt funds, getting on the right side of interest rate movement is more important than investing systematically.
I have simplified the argument too much. However, SIP may not always be the best way to invest in debt mutual funds.
Must Read: All you need to know about Debt Mutual Funds
Myth 4: SIP in any mutual fund will do
That’s not true either. You have got to select the right mutual fund. Performance of 10 year SIP in large cap funds varies from 4.36% p.a. to 13.22% p.a. For a SIP of Rs 10,000 per month, that will be a difference of ~Rs 9 lacs (Rs 23.9 lacs – Rs 14.9 lacs). This means choice of product is important too. You need to select the right mutual fund too.
Must Read: Focus on SIP returns
Myth 5: Date of first installment of SIP is the date of investment
Many who invest in ELSS have this confusion. Every installment of SIP is fresh investment and is subject to fresh lock-in (in case of ELSS), capital gains and exit load.
Suppose you start SIP in an ELSS of Rs 2,000 per month. The units you purchased with installment on January 20, 2016 is locked in till January 20, 2019. Units purchased through SIP installment on Feb 20, 2016 will be locked in till Feb 20, 2019. And so on.
You can extend the same argument for capital gains tax and exit load implications.
PersonalFinancePlan Take
- In my opinion, SIP is still the best way to invest in equity mutual funds for retail investors like you and me. I am not saying you cannot produce better results by taking any alternative approach. Just that you need great skill and discipline to pull it off. Not many investors can do that. At least, I can’t. Hence, it is better to stick to SIP for investment in equity mutual funds.
- The inertia of SIP helps you stick to investment discipline.
- If you were investing every month on your own (without SIPs), you may find it difficult to invest when every business news channel is spelling doom and gloom for the markets. Essentially, this way, you may not invest when the markets are down and come back when the markets are up. With such approach, you will invest only when the markets are at higher levels (or in an uptrend). So, your average price will likely be high.
- Take cognizance of the risks involved. SIPs are not fool proof. You can even incur losses.
- SIP does not provide guaranteed results. However, I feel the Indian economy should do well over the long term. And equity markets should well too over the long term. Therefore, your MF investments (through SIP) SHOULD do well too.
There is risk attached with every investment. You must be aware of such risk.
Image Credit: Simon Cunningham/LendingMemo[dot]com, 2013. Original Image and information about usage rights can be downloaded from Flickr.