Three wrong ideas about SIPs
Systematic Investment Plans (SIPs) from mutual funds (MFs) are a financial product innovation that has caught on like wildfire. The good news is that these SIP flows haven’t ebbed even with volatile markets. But while SIPs are a great tool for inculcating discipline into your investing habits, it is important to invest in them for the right reasons and not to fall prey to wrong notions about how they work. Here are the myths relating to SIPs that you shouldn’t fall for.
SIPS NEVER MAKE LOSSES
They can. SIPs are just a way to invest in MFs, which are market-linked products. It is in the basic nature of market linked products to go through phases of boom and bust. Therefore, if the stock market takes a long trip down South after you begin your SIPs, your portfolio will show a loss, as long as the decline lasts.
In 2017, Value Research conducted a comprehensive study on the real-life returns of SIPs across over 200 diversified equity funds for the 25-year period from 1992 to 2017. The study, after examining over 3.6 lakh monthly SIPs found that SIPs that ran for only one year had a 22 per cent probability of losses. But if investors continued with their SIPs for 4 years, the probability of making a loss fell to below 6 percent. This is quite intuitive, because big bear markets in India have rarely stretched on beyond four years.
In fact, if your SIP portfolio shows negative returns in the short run, you should take it as a sign that the SIP concept is working as it should. After all, the main objective of spreading out your investment over many months instead of investing at one go, is to avoid the damage to your portfolio from investing big sums at market highs.
SIP RETURNS ALWAYS BEAT LUMPSUMS
SIPs deliver better returns than lumpsums when you kick off your investment at high market levels, keep investing through a decline and then see the market bounce back into the green. However, there are other market scenarios where a SIP investment may earn lower returns than a lumpsum. One is in a vertically rising market. That’s because in one-way markets, SIPs average your costs upwards rather than downwards.
But if SIPs don’t always deliver better returns than lumpsums, why take the SIP route at all? Well, it is important because markets rarely rise vertically. Equity funds deliver the best long-term returns if we can keep faith with them during bear markets. Yet, most of us are behaviourally wired to put more money into equity funds when the markets are soaring higher, and to cut back when they fall. SIPs help us kick this bad habit by inculcating discipline.
STOCK SIPS ARE BETTER THAN FUND SIPS
Yes, stock SIPs can help average your buy price and multiply your money if you manage to pick stocks that outperform the markets on a multi-year basis. But finding such stocks is far from easy and requires you to track both company and sector closely.
Stock SIPs can backfire in three ways. One, when you accumulate a stock via SIP, you can end up owning a very high concentration of it in your portfolio. Two, multi-bagger returns in individual stocks come from identifying them when they are unknown, entering them at low prices and tracking the business to ensure that it is on course. A SIP, by putting your investment on auto-pilot, may detract from such close tracking. Three, if you’re a seasoned investor, you would know that no stock is a perpetual ‘buy’ at any price. Often, stocks or sectors that appear to be great buys at one point in time turn out to be avoidable in just a few months.
When you sign up for SIP in a MF, you are buying into a professionally managed portfolio. Should some of the stocks in the fund’s portfolio see a deterioration in business performance after you start the SIP, you needn’t worry because the fund manager is likely to replace them with better alternatives
To sum up, SIPs are great investment tools to inculcate discipline and steer you away from behavioural mistakes that extract a big price on your returns. But it is important to understand how they work to make the most of them!
(As published in IPRU Insights)