In recent months lakhs of investors have turned to systematic investment plans (SIPs) of mutual funds. Investors pump in close to Rs 4,500 crore every month through this option, compared to just Rs 1,200 crore a month in early 2014. The average ticket size of a SIP has also jumped from Rs 1,800 to Rs 3,200 per month. On the other hand, some other investors are feeling concerned about investing, when markets are close to all-time highs. SIPs help the investor average his cost over a period of time, fetching more units when prices are low and fewer units when prices are high.
In the current scenario, the SIP investor will accumulate units at higher prices, which will push up his average cost of purchase. Therefore, some investors want to sit out and wait for the markets to correct. Should you also stop your ongoing SIPs to avoid buying at high prices? Investors with long-term experience in the market, says no. Over the years, these individuals have learned to ignore the market noise and continue their SIPs month after month. This discipline has helped them build an impressive corpus.
Advantage of SIP
The systematic style of investing is actively promoted by practically everyone who gives advice about fund investing. Whether these are fund companies, advisors, or the media, an SIP is supposed to be the holy grail of mutual fund investing. Unfortunately, there seem to be a growing number of investors who have cottoned-on to the notion that SIP investing is some sort of magic.
The basic idea behind an SIP is that while the general direction of an investment (a fund or even a stock) is upwards, it is not possible to reliably predict the actual fluctuations that it may undergo as part of its general trend.
Instead of trying to time one’s investments, one should regularly invest a constant amount.
As time goes by and the investment’s net asset value (NAV), or market price, fluctuates, it will automatically ensure that when the NAV was low, you ended up purchasing a larger number of shares or units. Eventually, when you want to redeem your investment, all the units are worth the same price.
However, because your SIP meant that you bought a larger number of units whenever the price was low, your returns are higher than they would otherwise have been.
That’s the way it works, usually. However, there are circumstances in which a lump-sum investment can (in hindsight) prove to be better. This happens when during a given period, the equity markets never fall below the level they were at the beginning of that period.
In such a case, a lump-sum investment made at the beginning of that period will turn out to have the maximum gains because the buying price was the lowest at that point. The last one year is one such a period.
Generally, over a longer period of time, the ups and downs of the market will ensure that an SIP has the better returns. Moreover, SIPs mirror the actual fund flows of salaried people. They don’t generally have money available in large chunks to be invested as and when they feel like investing.
Beyond the arithmetic of returns, there is another reason why SIPs make sense. They are a great way to override the normal psychological instinct to stop investing when prices fall. In my experience, this is the real value of SIPs.
The normal tendency is to invest more when prices are high and to stop investing when prices fall. This is the opposite of what is the most profitable way of investing. SIPs force you to follow the opposite approach, much to your eventual benefit.