BT Insight: What does SIPs in stocks mean and how it helps in wealth creation

Investing in mutual funds using a systematic investment plan or SIP is quite common. But, of late, SIPs in individual stocks have gained popularity, which allow investors to gradually build positions in their preferred stocks if they don't have a lump sum amount to invest.

Moreover, with periodic investments, one can reduce the volatility risk, also keeping emotions at bay that may make one stay away from equities when one should especially nibble into them. For example, not many dared to invest in stocks during the COVID-19-led market crash in March, although benchmark indices have gained over 50 per cent since then.

"We tend to buy stocks when we feel it is available at an attractive price and most of the time we miss investing when it makes for the best time. If you have active SIPs in stocks, you will not miss investing in those stocks during the bottoms of the markets," says Umesh Mehta, head of research at Samco Group.

Also Read: COVID-19 fallout: SIP investments reach 22-month low in July at Rs 7,831 cr

There are two ways to initiate SIPs in a stock - either in terms of the number of shares or the fixed amount. "The SIP approach allows you to be your own fund manager when you can decide where to invest, how much to invest and when to start, pause or cancel an SIP," points out Tarun Birani (CFPCM), Founder & CEO, TBNG Capital Advisers.

Power of SIPs

Small steps make for big gains. This is the concept of an SIP, be it in mutual funds or stocks. For example, if you had invested in one share of HDFC Bank every month for 15 years, your invested amount of Rs 82,393 would have become a staggering Rs 2,01,231, an IRR (Internal Rate of Return) of 18.11 per cent. Similarly, buying one stock of Coforge Limited (formerly known as NIIT Tech) each month for 15 years would have fetched you Rs 3,51,018, an IRR of 26.01 per cent on Rs. 83,218 investment. (SEE TABLES)

However, unlike mutual funds, SIP investment in equities is not an easy task. If there are winners, there are losers too. The losses could be staggering if you have picked a dud stock for SIP investment. SIP in stocks requires much more agility than what you put in a mutual fund investment, where losses in some stocks get compensated by profits in others. Individual stock investment is riskier. You need to review your stock portfolio periodically lest the fundamentals of the stock change for the worse.

"Equity SIPs work well for those who are well versed with the ropes of investing. Thorough knowledge of investing in businesses and not mere stocks with the ability to withstand volatility is essential. Investors who have apt knowledge with the ability to invest time in selecting the right set of stocks and monitoring it periodically will benefit from the ESIP route," says Birani of TBNG Capital Advisers.

Here's what to keep in mind while taking the SIP route in stocks:

Also Read: Stamp duty to cut returns on liquid funds; should you switch to short-term FDs?

Stock selection is key

Stock selection plays a major role in SIP investment. Although most platforms let you start SIPs in any of the stocks, you should avoid doing it when taking exposure in mid or smallcap stocks. "Most of the retail investors have been doing equity SIPs wrong, they invest in penny stocks in hopes of high overnight returns and when the price starts moving down, they keep averaging it down (kind of a SIP) and double down on a losing bet," Mehta of Samco Group says.

It's advisable to pick stocks of largecap companies with good fundamentals and credible management at reasonable valuations for the SIP investment unless you are seasoned enough to hunt into mid and smallcap space.

"In the current environment, stocks like private sector banks and pharma stocks can be considered for ESIP. Banking stocks are down 20 per cent over the last one year but based on past experiences of 2008 and 2013 post fiscal stimulus, high-quality banks with high-quality managements are bound to get ROE expansion which will reflect in stock prices sooner or later. So, stocks like HDFC, Kotak Bank and Bajaj Finance can be considered for ESIP," says Birani.

Even if you have selected quality stocks for SIP investment, periodic review is a must. The Invest and forget approach wouldn't work in equity SIPs. "It's important to keep reviewing quarterly and annual reports of companies to continuously monitor them on various parameters like debt/equity, return on capital employed, earnings growth as well as management capabilities to understand their future growth prospects in detail," adds Birani.

Have an exit plan

Financial planners advise taking a long-term approach when investing in mutual funds. The same holds true for SIP in stocks too. Although you cannot run your SIPs for perpetuity, having an exit plan is a must. Linking your life goals with a particular or a group of stocks in which you are doing SIPs is required. Once you are closer to your life goal, you should consider booking profits.

"It's quite difficult to define the period of investment for an equity SIP, as it is a systematic and disciplined approach to invest in equity. It is supposed to be aligned with the investor's long-term financial objectives as it only generates a surge of profit over a period of time," says Jashan Arora, Director Master Capital Services.

How SIPs stack up against lumpsum investment

When doing an SIP in stocks, there could be three scenarios - the stock being on an upward trajectory, downward trajectory, or rangebound trend. "If a stock has been on an uptrend, the lumpsum amount will give you higher returns over the same amount invested through SIPs. If the stock remains at the same level at which you have bought it, then again lumpsum will take the lead. The only time when you make more money via SIP in stocks compared to lumpsum is when stock has been on a downtrend," says Nandkishore Purohit: Head, Digital & Distribution, HDFC Securities.

So, although among three scenarios, lumpsum will fetch you better returns in two, rather than chasing returns, SIPs are about convenience and curbing volatility risk. "Lump-sum equity investment has its constraints. First, it requires a hefty amount for investment. Second, the investor has to be sure of the time of entry in the stocks which requires a strong set of knowledge but the timing can still not be guaranteed. It would be irrational to say that every investor would have a similar level of expertise to begin with equity investments," says Arora of Master Capital Services.

SIPs are a convenient method to take exposure in stocks. However, this is only meant for specialised investors with a high-risk profile, as the individual stock selection is indeed risky. If you are not seasoned enough to pick stocks yourself, consult a financial advisor to create a diversified stock portfolio for SIP investment across sectors.