Systematic investment plans (SIPs), or dollar-cost averaging, as they are known globally, are becoming a preferred investment tool in India too. There are now almost 9.5 million SIPs in the mutual fund industry with an average ticket size of around Rs.3,000 per month. During my interactions as visiting faculty in professional colleges, an overwhelming number of graduating students now tell me that their first investment when they join the workforce would be starting an SIP for long-term investing.
The SIP culture is gaining ground elsewhere, too, but without adequate awareness. Gajendra Kothari, chief executive officer, Etica Wealth Management Pvt. Ltd, recently wrote about this in a Mint column (http://bit.ly/MINTgk1). When he visited his home town in Assam, some investors he met wanted to start SIPs for their children. It was a bit of a concern, because when he probed them about investing in mutual funds, they said they don’t want to invest in mutual funds but in SIPs.
Even some independent financial advisers position SIPs incorrectly. Their simple pitch is—invest in an SIP for 10 years or more and get over 15% annual returns. Even this is a concern. Don’t get me wrong, I do believe SIPs are a powerful tool, but keep expectations clear and understand how they work. Here are five things that you should know about SIPs, before you start that journey.
SIPs instil investing discipline
SIPs bring discipline in your investing. Period. These are not a separate product or an investment strategy. SIPs bring the rigour of regularly deploying investible surpluses as soon as they are available. These should be used for regular surplus income—from salary, business or other investments. You can start an SIP in an equity, balanced or debt fund. Choose the underlying asset based on your overall asset allocation and risk profile. Yes, the longer your SIP tenor (or even your lump sum’s), the better compounding works. So, effectively asset allocation and compounding give returns, SIPs bring in the discipline, cutting away emotional biases.
SIP and one-time investment returns may vary
SIP returns of an investment can be significantly different from that of the underlying point-to-point asset class. Most people believe that SIP returns will be higher than the point-to-point return as the average cost of investment is staggered. This is a myth. SIP returns depend on the return curve of the underlying asset movement and the volatility of the asset class. Returns from a debt fund SIP will mimic the underlying asset class but that for equity funds can be significantly different. For example, in Indonesia, one of the best performing emerging markets with 10-year annualised returns of 15.16% in rupee terms, SIP returns were 10.94% in the same period. In India, mid-cap funds gave a point-to-point return of 12.05% but SIP returns were 16.5%, clearly showing that SIP returns can be distinctly different vis-à-vis lump sum investments.
SIPs too need to be managed
One key concept people believe is that SIP investments don’t need to be managed or reviewed since you have taken a long-term view. Though you have committed to a SIP for a long term, one has to review the portfolio. You should see if the original tenet of investments still holds true for your original hypothesis of investment, at regular periods—preferably on an annual basis. In light of any new information that may emerge over the long tenor of an SIP—change of investment style, investment process, and so on—it is advisable to review these as you would do with any other investment. Consult your financial planner and take advantage of his professional inputs.
SIP tenor should be lesser than your goal horizon
Initially, when one starts an SIP in equities, regular instalments reduce the risk-return profile. But when you cross 50% of the SIP’s tenure, the incremental instalments do not reduce this risk significantly, and towards the end of the tenor, risk-return of the accumulated corpus is in line with market returns. Thus, if the market falls significantly in the last year of your SIP tenor, your overall SIP return will be affected. So, it is advisable that the investment horizon for SIP be lesser than your goal horizon. Alternatively, closer to your goal, reduce the accumulated corpus’ exposure of equities.
Don’t stop your SIP when the markets correct
In your investment journey, it is a given that markets will correct many times. Globally, behavioural finance studies have shown that it is at this time that investors stop further instalments. In standard finance, investors shouldn’t have pride or regret. But as behavioural studies show, most investors have a strong aversion to regret and emotional biases creep in when markets correct. Investors assign higher probability to future-based or recent events and start believing that the current trend, either up or down, will continue. Do not, and I repeat, do not stop your SIPs when the markets correct and you will be on your way to achieving your financial goal.