What is SIP?
A Systematic Investment Plan (SIP) is a staggered mode of investment in mutual funds. Instead of putting a lumpsum amount at one point in time, investors may prefer to put smaller amounts at regular intervals, so that they can secure an average price on the investment Some of the advantages of SIP mode of investment are:
- Avoiding unnaturally high buying price
- Organized manner of investment
- Taking advantage of a recessive phase in the market
- Can be matched with the cash inflow of the investor, e.g. after receiving monthly salary
Why SIPs are not fool proof
However, SIP is simply a mode of investment, and not a product in itself. Any SIP will carry the same risks as associated with the mutual fund itself. Most of the times, if the scheme is doing well, the SIP will do well too. However, there is no assurance that the capital will be protected or that the investment will generate positive return. SIP is a good way to mitigate risk associated with entering at a high price, but not to eradicate it completely.
For example, between 2007-2008, any SIP made would have not performed well, since there was a boom phase. The average buying price was quite high, and after 2008 there was a recessionary market due to the sub-prime crisis in USA. Therefore, SIP or not, all funds underperformed. However, any investments made after 2008 would have generated better returns, since the equity markets were at their lowest phase. An individual who may have invested at that time would currently have made good profits.
SIPs and timing the market
The equity markets are all about volatility and risk. The returns from equity are the premium for taking this risk. There is no way to time the market except by assumptions and technical analysis, which regular investors would not undertake. Therefore, SIPs are considered a safer mode of investing in equity funds as they bring discipline in the regularity of investment irrespective of the market highs or lows. The SIP dates will be honoured no matter what the NAV value is on that day. Hence, it tries to eliminate the market timing aspect of investing. But this does not mean that SIP mode eliminates volatility. A 12-18-month SIP may help to average out the buying price, but that doesn’t make the price fair or cheaper. A SIP during a boom year like 2007 would elevate the buying price instead of stabilizing or reducing it.
Case for Long term SIPs
SIPs are a great way to build long term wealth. Temporary market volatility must not discourage SIP investment, as it is during downturns that SIPs capture lower prices of buying. An investment horizon of 8-10 years would call for a 2-3 years accumulation stage, which must be continued even if the returns are seen negative, as the whole idea of SIP is to gather more units at cheaper prices during this stage. Thus, SIP is a good long-term strategy if followed with discipline and without passion. However, do remember that this is only a risk-mitigating strategy and not a risk-eliminating one.