GO FOR A REGULAR EXERCISE

We all have dreams, be it of owning a car, a house or going on a vacation or two to those fancy high-cost destinations. Besides, there are bigger plans at bay such as your child’s education and marriage and your retirement. These cannot be achieved from your monthly earnings alone; you need to invest and build a corpus over a period of time. Perhaps the best way forward is to have a systematic investment approach.

Small amounts saved and invested every month over a period of time can create a large corpus. Therefore, Rs 5,000 saved and invested every month for a period of 20 years would grow to Rs 30 lakh at a conservative rate of 8% and if you are lucky to earn a steady annual return of 15%, this could even grow upto Rs 76 lakh (see Benefits of compounding).

The mutual fund industry offers a structured route for such systematic investments through Systematic Investment Plans or SIPs, as they are popularly referred to. “It(SIP) is an ideal way for retail investors to benefit from the power of compounding and create wealth in the long term,” says A Balasubramaniam, chief executive officer, Birla Sun Life Asset Management.

The SIP facility not only inculcates financial discipline among investors, it helps the investor to negate the effects of market cycles as well. “SIPs help to create wealth in a convenient and time-tested manner while providing the benefit of averaging. In a rising market the amount invested will fetch lesser units while in a falling market the same amount will get more units thereby providing the investor a low average cost per unit. Consequently, it prevents the investor from trying to time the market,”adds Balasubramanian.

TYPE OF SIPS

Introduced in India in 1997, fund houses started off with monthly and quarterly SIPs and subsequently offered a daily SIP option as well to inculcate the habit of saving and investing on a regular basis. Therefore, you can now invest in SIPs with frequencies ranging from daily, weekly, fortnightly, monthly or quarterly depending on your financial goals.

Not just that, investors are now looking at making SIPs with multiple dates in each month, as well as perpetual SIPs, that is, SIPs which have no end date, although these SIPs can be stopped by the investors anytime they need the money.

SYSTEMATIC OR LUMP-SUM?

An SIP is for you if you are a first time investor, not clued to the vagaries of the equity markets. According to Kapil Mokashi, senior manager, equity & mutual funds advisory, Sharekhan, SIPs works best for investors having long-term goals, say, for their child’s higher education or marriage or creating a retirement corpus. In each of these cases a specific monthly amount can be allocated towards these goals.

To illustrate, let’s take the case of IDFC Premier Equity Fund, one of the best performing funds in the mid-cap category. The fund saw a major fall in its net asset value(NAV) from January 2008 to March 2009 only to emerge as one of the best performers in 2010. Had you invested Rs 5000 as an SIP into the fund at the beginning of every month since January 2008, your investment would have been worth Rs 3 lakh today, an IRR (Internal Rate of Return) of 27%. Compared to this, a lump-sum investment during the same period would have fetched you an IRR of only 3%.

Investing by way of an SIP would have allowed you to capture the downturn experienced by the fund, whereas the lump-sum does not allow you to take advantage of this.“In a downturn one is better off with an SIP considering you start seeing good positive returns slightly earlier when compared to a lump-sum,” says Gaurav Mashruwala, a certified financial planner.

“A lump-sum investment works for a seasoned investor, who does not get disturbed by market turbulence,” says Mashruwala. “Also, if you are planning for your child’s future and have a few years in hand, you could look at investing at one go. Making a lump-sum investment is a much longer call,” he adds.

However, at times, there may be a change in the fund mandate or fund manager in which case you could be stuck with the investment if you have bought it at a particular price.

If you have a lump-sum but wish to invest that every month systematically, you could opt for a Systematic Transfer Plan(STP) where money is debited from a liquid fund in the same fund house and transferred to the equity fund as per the period specified by you.

AVERAGE GAINS

Does this strategy work under all market circumstances or could you get caught on the wrong foot at times? There are times when an SIP could disappoint. “SIPs tend to underperform in a constantly rising market since the basic principle of an SIP is cost-averaging,” says Kapil Mokashi of Sharekhan. If markets are constantly rising, you would end up investing at higher prices and get lower number of units.

Take for instance the period from 2004 to 2008, when the Nifty moved up from 2,000 levels to 6,000. During this period, had you invested Rs 5,000 on a monthly basis from January 2004 until December 2007 (before the financial meltdown) your investment would have been worth Rs 5.75 lakhs until then. In comparison, if you had invested Rs 2.4 lakhs (Rs 5000x48 months) as a lump-sum in January 2004, your money would have grown to Rs 7.8 lakhs.

Subsequent events, however, would have negated all the gains. In 2008, the Nifty fell from 6000-odd levels all the way to 2500! “An investor who invested in lump-sum would have had all his gain wiped out in a single year,” says Mokashi. “It is not easy to time the market, hence one should adopt a strategy where timing is not required,” he adds.

Lump-sum investment would have been profitable only if one would have entered at 2000 or 3000 (bottom) and exited at 6000(top), a seemingly onerous task even for an expert, leave alone the small investor.

HELPED BY TURBULENCE

“SIPs will lose their edge if markets are not volatile, and there are no ups and downs since the averaging concept will not work,”says Mokashi. In real life, this is seldom the case. It can be clearly seen in the above graph that both the best performing funds and the worst performing funds, have seen major ups and downs in their NAV.

Take for instance, the JM Basic Fund, one of the worst performing funds in its category of late, was a star performer from January 2006 until January 2008, led by the infrastructure boom. A lump-sum of Rs 1.2 lakh invested into the fund during this period would have grown to Rs 3.64 lakh(a CAGR of 75%). Had you not exited this fund at that point, today the value would have been the same as your investment value, not to mention the fact that the fund lost 50% till December 2008, only to recover later. Further anybody having invested into the fund in January 2008 by way of a lumpsum would have lost 18% on an annual basis compared to a zero loss or profit through an SIP route.

According to Balasubramaniam, in hindsight there will be instances where investing lump-sum may have given higher returns. But then that doesn’t mean investors will be making higher gains as compared to SIP if he starts investing at a particular time, since no one can predict the market. Adding to this is the fact that one might have to withdraw money based on their needs.“Also SIP is not heavy on the investor’s wallet with a fixed amount being invested every month as per investor’s convenience rather than lump-sum amount which may or may not be available every time,” adds Balasubramaniam.

If there are no immediate financial needs investors should look at continuing the SIPs as long as they can. This is important as they get the benefit of being for a longer time in the market while also availing of the benefits of compounding.