A long-term investment strategy(misunderstanding of SIP)

Systematic Investment Plans (SIPs) are much misunderstood. For one, investors often mistake SIPs as an
investment avenue rather than a mode of investing in mutual funds. Then there are investors who invest in SIPs
expecting quick results without fully appreciating the need to invest via SIPs for the long-term.
In an earlier article, we discussed how SIPs are perceived incorrectly by many investors as standalone investments.
This explains why one of the most common queries we receive on the website is which is the best SIP?
Unfortunately, these investors have not been educated by their investment advisors about SIPs i.e. SIPs are only a
mode of investing and not an independent investment avenue.
Which is the best SIP?
That’s a question we routinely hear nowadays. Ever since the equity markets have been engulfed by volatility, the
most frequently heard piece of advice is – invest via the systematic investment plan (SIP) route for the long-term.
While regular visitors and clients of Personalfn have since long bought into the merits of SIP investing, we are
rather surprised to note that it took a prolonged volatile phase for most investment experts/advisors to appreciate the
importance of SIP investing.
Coming back to the original question - which is the best SIP? Thanks to all the hype around SIPs, several investors have
been led to believe that the SIP is an investment avenue. Furthermore, the panacea to the present testing phase is to select
the best SIP and get invested therein.
The SIP is simply an investment mode i.e. a means to invest in mutual funds and not an investment avenue. When
an investor chooses to invest via an SIP, he makes investments (usually) in smaller denominations at regular time
intervals as opposed to making a single lump sum investment. The underlying intention is to benefit from the volatility
in equity markets by lowering the average purchase cost. In this article, we discuss the pros and cons of SIP investing.
How an SIP helps…
As mentioned earlier, the most important role of an SIP is to lower the average purchase cost of an investment
over the long-term. This is possible when equity markets experience a turbulent phase. Since the investment
amount for each SIP installment is fixed, the investor gains by receiving a higher number of mutual fund units.
An example will clarify this better. Suppose the monthly SIP is for Rs 1,000 and the fund’s net asset value (NAV) is
Rs 50; this will lead to 20 units being credited to the investor. However, in the next month on account of the volatile
markets, the fund’s NAV falls to Rs 40. This will lower the average purchase cost; as a result, the investor will have
25 units credited to his account. This is how an SIP can help investors benefit from volatility in equity markets.
Lack of disciplined investing is one of the major reasons for investors not achieving their financial goals. For example,
often monies that are kept aside for investments end up getting used for other purposes. As a result, the investor is even
further divorced from his goals. An SIP ensures that the investor stays the course by investing in a disciplined manner.
An often heard excuse for not investing is lack of monies. SIP takes care of this problem by lowering the minimum
investment amount. For example, the minimum investment amount for a lump sum investment in a diversified equity
fund could typically be Rs 5,000; conversely for an SIP, it can be as low as Rs 500. As a result, investing via the SIP route
is lighter on the wallet..
Timing the market is a popular pastime with several investors. Investors have an inexplicable urge for timing
markets and aim at getting invested when markets have bottomed out. It’s a different matter that timing markets to
perfection and doing so consistently is beyond most investors. SIPs make market timing irrelevant.
Having discussed the benefits of SIP investing, now let’s consider the situations when an SIP won’t deliver…
1. In rising markets
An SIP may not be able to lower the average purchase cost if equity markets rise in a secular manner. In such
a scenario, the average purchase cost could actually rise. So in a market rally, SIPs could prove to be more
expensive vis-à-vis a lump sum investment.
2. A directionless SIP
A directionless SIP is one that does not form part of an investment plan; in other words, it’s an aimless SIP.
The SIP is not an ‘end’; instead, it is the ‘means’ to achieve an end. Hence an SIP in isolation does not make
‘financial’ sense. Instead, the SIP should form part of an investment plan aimed at achieving a predetermined
objective (like providing for a child’s education or buying a house).
3. An SIP in a poorly managed fund
Investing via an SIP doesn’t improve the prospects of a poorly managed fund. Such a fund stays the same,
irrespective of the investment mode. Its shortcomings will not be eliminated by an SIP. Hence the key lies in first
selecting a well-managed fund that is right for the investor and then investing in it via an SIP.
As can be seen, the SIP mode of investing has a fair number of advantages to offer; conversely, there can be
instances when it may not deliver as expected. Investors on their part should make well-informed investment
decisions after acquainting themselves of both the pros and cons.
Minimum tenure of an SIP

Another misconception investors have about SIPs is with regards to the minimum tenure. Most fund houses have a minimum
SIP tenure of 6 months. This leads investors to believe that 6 months is the ideal time frame for investing via SIPs (just like a
lot of investors invest Rs 5,000 in mutual funds simply because that is the minimum investment amount for several mutual
fund schemes).

In our view, investors should ideally invest via SIPs over at least 2-3 years. This way they can exploit the most critical benefit
of an SIP rupee cost averaging. Let's understand how this is possible.

For an SIP to deliver the goods, it must witness a falling market. This way the investor can average out his cost of purchase. If
the investor does not witness a downturn, i.e. he is only exposed to a market rally, the average purchase cost of his SIP will
rise over a period of time.
SIPs in a rising market

(The example is for illustrative purpose only.

We have assumed that the SIP is done on the first trading day of the month; SIP amount is Rs 500.)
In the above table the average purchase cost of the SIP is Rs 12.45. Clearly, the SIP has not worked in the
investor's favour. Why is that? Because if he had instead invested lumpsum in January, his purchase cost
would have been Rs 11.00 as opposed to the average purchase cost of Rs 12.45 over a 6-month period.
SIPs in a falling market

(The example is for illustrative purpose only.

We have assumed that the SIP is done on the first trading day of the month; SIP amount is Rs 500.)

However, if the investor had opted for a longer investment tenure of say 12 months, he could have benefited from greater
fluctuations in the mutual fund's NAV. These fluctuations which arise over a market cycle lower the average purchase cost of the
SIP over the long-term.

This is apparent from the above illustration. As is evident from the table, if the investor had taken an SIP for 12 months (instead of 6
months) his average purchase cost would have declined to Rs 11.50. Compare this with the average purchase cost of Rs 12.45
for a 6-month SIP.

It can be argued that there is no way for the investor to know when there is likely to be a turnaround in the markets (in this case a
downturn). That is exactly our point. Since the investor does not know when markets will fall (and lower his average purchase
cost), he must opt for a longer SIP tenure. Or at least he must manage his investments in a manner so that when his existing SIP
terminates without witnessing a dip in stock markets, he can extend it further. This way should the markets fall, his SIP can benefit
from a dip in the mutual fund NAV which in turn will lower his average purchase cost.

Points to remember before opting for an SIP

1) Ironically, while SIPs are meant to eliminate market-timing, investors must opt for a long-enough
SIP tenure so as to 'time' the market downturn.
2) SIPs are equally beneficial in a falling market. Most investors believe that lumpsum investments
(as opposed to SIPs) prove more beneficial in a falling market. This is only partly true. Having an
SIP in operation during a falling market can ensure that investors stand to benefit should markets
fall even further.

POWER OF SIP Kyon !! Chonk Gaye Na !!!

Rs.5000 * 96 = Rs.16,69,397 As on 31/10/2008/ Reliance Growth Fund(Growth) : 34.41 % PA