SIPs are a safer option during market volatility

A thumb rule of investment is that one must not take too much risk. One way of ensuring this is systematic investment plans (SIPs), in which a person can invest in a disciplined manner at regular intervals without being too adventurous.

"In volatile markets, it is always good to go on a SIP mode as it helps one get the benefit of cost averaging over time," says Anil Rego, CEO & Founder, Right Horizons. As markets keep rising and falling all the time, the cost of buying units is averaged out over time as the investor gets more units when markets are down.

"Even when a client wants to invest a lump sum, we advise him to enter a debt fund first and do systemic transfer to equity funds. This helps him manage volatility and earn optimal returns," he adds. SIP can be monthly, quarterly or half-yearly.

BENEFITS OF SIP

Riding through volatility: If you are among those who are nervous about investing in equity funds because of ups and downs in the market , SIP will work best for you. It not only minimises the risk of losses due to fall in equity markets but also saves you the hassle of timing the markets, that is, investing when they are trading lower and exiting when they are rising.

In the last five years, the broader market, the BSE Sensex, has moved from 18,000 levels to 26,000, albeit with huge volatility. Now, let us assume you invested Rs 10,000 every month into an Index Exchange Traded Fund (ETF) between September 2010 and September 2015. Your investment of Rs 6 lakh would have grown to Rs 8.04 lakh today with 11 per cent compounded annual growth rate (CAGR). The lump sum investment would have grown at eight per cent CAGR. The higher SIP return is due to the fact that you bought at various levels, both when the market was rising as well as when it was falling, averaging your cost. The average SIP return of large-cap diversified equity funds during the period was 14 per cent. Diversified equity funds are actively managed and, hence, are able to deliver superior returns.

SIPs thrive on volatility: As volatility increases, the divergence between SIP and lump sum returns widens. For instance, the same amount of Rs 10,000 invested in a SIP of a mid-cap fund would have delivered a return of 26.44 per cent; the lump sum return would have been 18.06 per cent. This is because mid-cap funds are affected by considerable volatility in stocks they hold, especially in a downturn. Hence, investors are likely to benefit more if they invest via SIP in these funds.

Power of compounding: A SIP allows you to gain from the power of compounding if you are investing for goals that are some years away. An amount of Rs 10,000 invested every month for 10 years will grow to Rs 23 lakh at a modest CAGR of 12 per cent.

SIP ensures disciplined investing: There will always be times when the urge to splurge is high. This makes it difficult to contribute towards creation of a large corpus over a long period. SIPs enable you to do this by the discipline they impose. Since the amount gets invested automatically at fixed intervals, the chances of you continuing the investment for a long period are higher. Meenakshi of FundsIndia.com says while designing a SIP portfolio, one must first decide the allocation, that is, how much money will go into what type of funds. Focus on three types - large-cap, small/mid-cap funds and debt funds. "A typical allocation should be 50 per cent in large cap funds, 20-30 per cent in small/mid cap funds and the rest in debt funds," he says."Second, decide the number of schemes in your portfolio. Given that we have three prime asset classes, the portfolio should have at least three schemes," he says.

Fund houses are now offering several variants of SIPs for convenience of investors.

Systematic Transfer Plan: Under STP, a person puts a lump sum in one scheme (usually a fixed income fund such as a liquid fund) and regularly transfers a fixed amount into another scheme (usually an equity fund) every month on a specified date. The idea is that if you have a large surplus, you must invest in equities in a staggered manner so that the volatility risk in minimised.

Flexi-SIP/STP: Under SIP, one usually invests a fixed amount every month or quarter. This is ideal for investors who earn a fixed income every month. However, for those with no fixed income, investing a specified amount every month may not be possible. Such investors can opt for flexi-SIPs, which offer flexibility of investing any amount within a range (say Rs 1,000-10,000). The investor has to issue an ECS mandate for the maximum amount, which can be as high as 10 times the minimum amount. A flexible STP option is also available. It allows you to transfer a variable amount from one play to another periodically.

Value averaging plan: Under VIP, the investor sets a target for monthly growth and adjusts the invested amount according to the performance of his fund. Take a person who invests Rs 5,000 in a fund and sets a 12 per cent growth target every year. Therefore, he expects his fund to return one per cent every month. This means his investment should become Rs 5,050 by the end of the one-month period. However, if his investment grows only to Rs 5,025, next month he will increase the amount to Rs 5,025. If it grows by Rs 100 to Rs 5,100, he will invest only Rs 4,900 instead of Rs 5,000. This means the person deploys more money when markets are down and less when they are up. Hence, he buys more units on dips.

DOES SIP ALWAYS WORK?

SIPs underperform in a consistently rising market as its main advantage of cost averaging is not realised in such a case. You end up investing at higher prices and keep getting fewer units. Take the period from 2004 to 2008, when the Nifty moved up from 2,000 to 6,000 levels.
 
During this period, had you invested Rs 5,000 a month from January 2004 until December 2007 (before the financial meltdown), your investment would have been worth Rs 5.75 lakh until then. In comparison, if you had invested Rs 2.4 lakh (Rs 5,000x48 months) as a lump sum in January 2004, your money would have grown to Rs 7.8 lakh.

(In association with Mail Today Bureau)