Questions that investors frequently ask about SIP
Written on Thursday, November 5, 2015
By Sudipta Mitu
Systematic Investment Plan has become a very popular mode of investing in mutual funds. But, with the markets turning volatile in recent months, investors may be tempted to stop their SIPs and exit their equity fund investments. Hence, let us revisit the concept of SIP and answer some of the most popular questions that investors ask about this mode of investing.
1. Why should I invest via SIP?
When you invest via the SIP mode, you put in a small sum of money at regular intervals. You give an ECS mandate to your bank, so that a fixed sum is pulled out of your account and invested in a fund of your choice. This mode of investment suits retail investors, especially the salaried class, who are able to put away small amounts every month. Over a 30 year period, these small amounts can build up to a substantial corpus and help the investor meet his financial goals like children’s education and marriage, retirement, etc. Thus, SIP inculcates discipline in investing.
SIPs also take advantage of the power of inertia. Laziness is one of the great weaknesses of mankind. By using SIPs, you can make sloth work in your favor. Once you have given the mandate, you only have to periodically check the performance of your fund. If it is doing well, you have to just sit tight and watch your investments grow.
SIPs also offer the benefit of rupee cost averaging. Your fixed investment every month buys you fewer units when the market is up and more units when the market is down, thereby lowering your average cost of purchase of units over the long term. The low entry cost augments your overall returns of the fund. Thus, instead of fearing market volatility, you can welcome it when you use the SIP mode, as SIP investments benefit from high volatility.
2. Should I make a lump sum investment or avoid doing so?
The most practical reason for not opting for the lump sum mode of investing is that it does not gel with your financial reality. Usually when people begin investing, they don’t have huge sums of money to invest. So instead of waiting for the day when you will have a large sum, you can begin an SIP with as small a sum as Rs 50.
The second reason for not using the lump sum mode is the market volatility. What if the market is near peak levels and then nosedives 50% after you have put in a huge sum of money? Most investors would be traumatized by such erosion in the value of their investment.
You should also avoid making lump sum investments to bypass the problem of market timing. When you invest a huge amount at one go, you want to do so when the market is low and you want to sell when the market is up. But whether a particular market level is low or high is apparent only with the benefit of hindsight. You may buy at a certain level thinking that the market is at a low, but it may sink even further after you have made your purchase. Similarly, if you sell thinking that the market is high, it could rise even higher thereafter, making you regret your decision. Instead of wrestling with the dilemma of market timing, which even experts often fail to get right, go with the SIP approach where you buy a little at every level.
3. Will my SIP investment beat lump sum investments?
Though, this question is asked often and is also widely discussed in the media, what you must understand is that it is an apple-to-orange kind of comparison. The two modes of investing are different and hence not directly comparable. When you make a lump sum investment, the money gets to work right from the first day of investment. In case of an SIP, your money gets deployed in the market gradually. So, if the return from lump sum investing is higher than from SIP investing, that is because the former has a head start.
Also, different modes may do better depending on the market level at the time of entry and exit, and also on how the markets performed during the period of investment. But any conclusion that you get after running the numbers will be period-specific, and it would be futile to conclude based on them that one form of investing is better than the other. We would, however, recommend SIP over lump sum investing for the reasons mentioned earlier: discipline, better suited to financial realities, to avoid getting burnt by market volatility, to take advantage of rupeecost averaging, and to avoid the dilemma of market timing.
4. The market is down. Should I stop my SIP?
To stop your SIP when the equity market has fallen is the worst possible mistake you can commit. To benefit from an SIP investment, you need to stay invested across market cycles. If you continue with your SIP, you will be able to purchase more units of the mutual fund during the downturn. Your long-term returns will benefit from those low-cost purchases. When you stop your SIP, you also flout the principle of asset allocation, which requires that you maintain your allocation to different asset classes at a pre-determined level, irrespective of market conditions. By stopping your SIP, you tilt the asset allocation of your portfolio away from equities and towards cash, a decision that will harm your portfolio returns. Going by the logic of asset allocation, you should, in fact, invest more in the equity market when it is down.
5. Are there circumstances when my returns could be poor despite using an SIP?
Yes, in certain market conditions, your returns could be poor despite using an SIP. Remember the period from 2003 to 2007, when the Indian market witnessed a secular bull run. This meant that investors were gradually accumulating mutual fund units at increasingly higher levels of the market. Then, in 2008 the market witnessed a precipitous drop. In those days, even three- and five-year SIPs were giving negative returns. So, while SIPs can alleviate the pain of market volatility, they don’t take away the risk of investing in the markets entirely. The only thing investors can do when they witness such a downturn is to wait patiently for the markets to revive, which they inevitably do.
6. If lump sum investing is a strict no-no, how do I deploy a large windfall, such as money bequeathed to me by a benevolent uncle, or my annual bonus?
If you have a large sum of money to deploy, it may be smarter to use the STP (systematic transfer plan) than SIP. In an SIP, you keep the money in a savings account, where it will earn only 4% while it is waiting to be deployed. In the STP route, you first invest the money in a liquid fund of the fund house whose equity fund you are interested in. From here it will be invested gradually in an equity fund. And while the money is waiting to be deployed, it will earn a higher return in the liquid fund than in a savings account.
Remember, however, that you will have to pay short-term capital gains tax and an exit load when you transfer money from a liquid fund to an equity fund. In some cases, fund houses waive the exit load when you transfer money to an equity fund belonging to the same fund house.
7. Can you offer tips to make SIP investing smarter?
Make use of what is called a stepup SIP. Most salaried employees get annual increments. If they can increase their savings in the same proportion as the rise in their salary, then they should opt for the step-up SIP option. Increasing the amount that you save every year will provide a big boost to your final corpus.
8. What is the right frequency for an SIP?
Traditionally, you could do monthly SIPs, but nowadays mutual fund houses offer options like daily, weekly, fortnightly, monthly, quarterly and even yearly. If you do the calculations, the difference in final returns over the long term using these different SIP options is not very high (see table). Therefore, your decision should be based more on practical considerations.
If you use a very high-frequency SIP, like daily SIP, it will mean multiple entries in your bank and mutual fund statements. Calculating capital gains on so many transactions will also be a nightmare. You will also have to ensure that there is money in your bank account to meet the daily fund requirement.
If you go for a very low-frequency SIP, such as quarterly or yearly, you will not be able to get the advantage of rupee-cost averaging. Your investments will begin to resemble lump sum investing and you will again run the risk that arises from market timing. You could also miss out on investing unless the fund house sends you a timely reminder. In the final analysis, we would suggest sticking to the monthly SIP, or at best going for the fortnightly option. The benefit of the monthly option in case of salaried people is that it aligns their mode of investment with their cash flow.
9. Should I use SIP in a debt fund?
Equity funds are more volatile than debt funds. Therefore, using the SIP approach is more beneficial in the case of equity funds than in debt funds. Debt funds grow by earning steady and regular interest income. If you have a lump sum, there is no need to adopt the STP approach in debt funds. It may be wiser to go ahead and invest the entire amount. However, salaried employees or those who lack a lump sum may adopt the SIP approach in debt funds.