Let’s start this post with a hideously true, oft-repeated cliché – we are all going through unprecedented times. While the death toll, fear and social isolation have played their part, seeing the blood bath in the market early this year has added to the woes of investors. The scepticism for investing in equities has overflowed to raising doubts even about the poster boy of mutual funds – SIP.
Look around and there will be enough articles either dissing the humble route of SIP or investors writing in with their disillusionment. So, what should the investor really believe in at this time? Does SIP still hold a place or is it really the end of the golden era of SIPs?
Over the years, the praise and adulation for SIP has kept adding on and pretty much snowballed it into a silver bullet which can be a go-to for anything. But, now is a good time to look around and break down some of the myths and go ahead with using the SIP more smartly.
1: SIP is the way to go for large amounts of cash in hand
Yes, equities are volatile and for a large sum, lumpsum investment is not ideal. But, even for a large sum of money it is recommended to spread out the investment only to a period of 6-12 months. The reason is the fact that beyond that period, the cost of holding cash outweighs the risk of investing in equities. While you can do a micro-term SIP, it also has a sibling by the name of STP or Systematic Transfer Plan. STP works better to spread out cash at hand for two big reasons. One, you transfer the total amount to be invested to a linked liquid fund, thereby reducing the risk of chickening out or spending the money on some other avenue. While SIP is good for future cash flows, STP helps to commit existing amounts to investing. Two, STPs are far more flexible with their entry points in the market. For instance, while you could chop your amount into big monthly chunks, you could also hack them further to weekly instalments or keep chipping for bite-sized daily STP, too. Most SIPs operate on a monthly frequency and you would need to start multiple SIPs to achieve the same objective.
2: You should start and stop SIP to time the market
When we say time the market, while there might be investors who think they will be able to stop their SIP when the market is too high, that never happens. When the market zooms up, the optimism and the exuberance all around rubs off and we are pretty sure it will keep going up.
It is only when things are not very rosy that many investors choose to press the pause button on their SIPs. However, as the famous saying goes – it is more important to spend time in the market than time the market. As far as possible, unless there is a cash crunch, do not stop your SIPs.
Let’s look at an example. Suppose you started a Rs. 20,000 SIP in July 2019 with an investment date for the first market day of each month. We will consider two scenarios. One, where you let fear prevail and stop your SIP for 3 months – namely April, May and June 2020. Two, where you continue with your SIP unperturbed. How do the two situations look at the end of September 2020? To ensure no fund bias, let’s simply take the Nifty 50 numbers at the start of the month into consideration.
In the first scenario, your average purchase price would hover at about 10,821 which is almost 5% less than 11,367 which would be your average price with the 3-month pause. On September 30, 2020 Nifty 50 closed at 11247.55 which means that with the first strategy your total SIP would still be in the red whereas had you continued with the SIP there would now be a 3.94% gain to show for it.
Most importantly, your total value of the invested amount differs by 31%!! Before you rub your eyes and are convinced there is a typo, there’s actually a catch here. We have included the fact that since you did not stop the SIP, you also end up investing extra Rs. 60,000 which takes you closer to your goal anyway than pausing it would have.
The point is no one can ever be sure of which way the market will turn. If you have a long enough horizon for equities, stay put and just keep investing.
3: Keep the amounts in SIP constant
SIPs are a long term game which move and evolve along with our financial lives. We don’t expect to be stagnant or remain the same through life. Then why should our SIP amounts be stuck in the past?
Let’s take two examples. Assuming a 12% return on equities, suppose you start with investing Rs. 10,000 a month. You continue with the SIP for 10 years. In one scenario, you keep your SIP static and end up with an amount of Rs. 22.4 Lakh. In the second scenario, you increase the SIP instalment amount by a mere 5% every year and you reach an amount of almost Rs. 27 Lakh.
The difference is far starker for a longer term goal like retirement. Let’s take a case where you end up investing for 20 years. In one case, you again start with investing Rs. 10,000 per month choosing to keep the amount constant. You chalk up an amount of almost Rs. 92 Lakh. However, in the other case, keeping in tandem with your salary hike you end up increasing your investment amount by 5% each year. In that case, you end up with almost Rs. 1.28 Crore! Of course, by the end of it, your SIP amount has also grown to Rs. 25,270.
The point here is that SIPs are as good as the amount you end up investing. While they do grow with time, more the starting matter to compound, higher the margin for cushioning market and volatility shock while still continuing to move towards your goal.
4: You can start and forget SIPs
When it comes to mutual funds, most investors will sagely nod their head on listening to the two golden phrases – “asset allocation” and “rebalancing”. When it comes to SIPs though, somehow those concepts seem to vanish in thin air. Most of us forget that those basics stay in place even if the medium of investing (which is what SIPs are) changes. So, build up a substantial portfolio for the first two years and then every year check in for a review. However, a word of caution. Do not equate portfolio review with blindly chasing after returns. But, there are some questions you should ask. Have any funds changed drastically from their original allocation? Has any fund undergone a fundamental change in it’s attribute that makes it unsuitable for your portfolio? Do you need to trim off the fat from funds that have had a great run and add it to those which have caught the wrong end of the cycle? A periodic review is helpful to keep on track.
5: SIPs are meant only for equity funds
When we talk about SIPs, almost all examples come from equity funds. But, conventional investing wisdom suggests varied asset allocation. As mentioned earlier, SIPs are a means to build a corpus using future cash flows. Hence, as an investor go back to the basics of devising an asset allocation that you are comfortable with as per your risk appetite, financial goal and investing horizon. If it is 20-80 for debt-equity, then split your SIP also accordingly. Although, remember that each SIP instalment will transition from short term to the long term with respect to capital gains as per it’s respective investment date.
With SIPs there are just a few things you should keep in mind. One, the inherent risks of investing continue to hold true. Two, the basics of investing and asset allocation need to be adhered to. Three and most importantly, SIP is a means of strategically investing future cash flows but not a silver bullet to eliminate the risk element. Till the time you remember these three mantras, chances of being disappointed with SIP will be lesser.