Wednesday, 1 August 2012

SIP – Systematic but not Safe Investment Plan

SIP or Systematic Investment Plan is a very popular term promulgated by mutual funds, their distributors and financial planners. SIP is the connotation for Systematic Investment Plan which is generally marketed as a safe and sure route of investments in equities to outperform the markets and create wealth over the long term. SIP is certainly safe for mutual funds and distributors because they get committed continuous money for the long term on which they can earn fees and commissions. It is also safe for the financial planners to recommend because if anything goes wrong then they can blame the SIP system. But, however is SIP safe for an investor? This article attempts to examine and bisect SIP in a manner probably never done before.

What is a SIP?
SIP is nothing but a systematic regular investment plan, mostly monthly or quarterly, of a particular amount in a mutual fund scheme. It is similar to a bank recurring deposit. It allows an investor to deposit small amount at regular periodic intervals in place of a single heavy one-time investment.

Benefits of Investing through SIP 
The major benefits of investing through SIP route are as follows:

Ø  Rupee Cost Averaging
This is supposed to be the primary benefits of investing through the SIP route which has made it so popular among investors. What is the cardinal principle of buying anything in this world – buying when the price is low. Rupee cost averaging simply does that by automatically buying more when the price is low and purchasing less when the price is high. This is the primary advantage of a SIP on which it is being sold and marketed – but does this really benefit the investor – read on.

Ø  Regularity of Investments
SIP regularizes investments by making it a mechanical boring process which is what it is supposed to be. It removes human judgment from the decision making process. It instills discipline in the investor and helps him stay focused, investing regularly for the long term.

Ø  Power of Compounding
Some term compounding as the “eight” wonder of the world and it really is. Very few people realize how powerful compounding is over long periods of time – small items compounded regularly over longer periods yield big difference in the final results. For example, Rs.5000 invested monthly at a 10% p.a. return over a 30 and 35 year period would accumulate to Rs.1.13 crores and Rs.1.90 crores, respectively – a massive difference of Rs.77 lacs. Hence, just by starting 5-years earlier, a person would ultimately be able to accumulate Rs.77 lacs more – that is the power of compounding.

The first one i.e. rupee cost averaging is the general perceived benefit of investing through a SIP route – the other two ones are advantages of investing through any regular investment method. Now, let us consider that whether is SIP really superior to lump sump investments or not.

SIP – Is it really superior to lump sum investment 
Is SIP always superior to lump sum investment option? Certainly not – SIP is not always a better method than the lump sum investment option. Why? The Sensex is around 17000 levels today and if you know with certainty that it is going to become 30000 after one-year than you would obviously be better off buying your entire investment quantity today at probably the lowest value rather than keep averaging upwards month after month through the SIP route. On the other hand, if you knew that the Sensex is going to go down to 12000 in the next one-year then forget SIP or lump sum, you would be richer not investing at all in equities. Therefore, SIP is not some magic that it will outperform lump sum investing method or always give positive returns, even during the long term. So, what are the conditions under which SIP works? The next section examines that.

Conditions under which SIP would yield positive results

SIP route would ideally yield positive results only under the following conditions:

Ø  Bull or Rising Market
SIP would yield positive results in a bull or rising market as every new purchase, although made at a higher cost, is ultimately valued at an even higher price. However, as seen earlier, in such a case it would be wiser to buy the entire investment lump sum rather than keep “averaging upwards” through the SIP route.

Ø  Volatile but rising market
SIP should finally perform well in a volatile but ultimately rising or bull market. This would be the market kind in which the “rupee cost averaging” would work most favourbly for the investor as the volatility would lead to the best possible average price. The final rising or subsequent bull market would ensure that the end price is higher than the average price.

Ø  Market in Median range, corrects downwards and then moves up
This would be another case in which SIP would perform well and in all likelihood better than initial lump sum investment. This is because the investor will get the assistance of the intermediate correction to “lower his average cost”.

But then does this mean that SIP works under all market conditions. Certainly No. So let us now examine the market conditions under which SIP would not work.  

Conditions under which SIP would not yield positive results

SIP route would not work under the following market conditions:

Ø  Bear or falling Market
SIP would not work and infact yield negative returns in a bear or falling market as every new purchase, although made at a lower cost would eventually be valued at an even lower price. In such a market scenario, SIP might outperform lump sum investments as the investor will get the benefit of “averaging downwards” but the investor will still lose money – I believe it should be the endeavor of every investor to make money by investing and not simply “lose less”.

Ø  Sideways Market
SIP would not work in a sideways market as you will not get the benefit of rupee cost averaging and the final value would be closer to the average cost. In a sideways market, the difference between the performance of SIP and lump sum might not be material.

Ø  Market in Median range, moves upwards and then moves down
This would yet be one more case in which SIP would not perform because the investor will actually be hurt by the SIP as he would be “averaging northwards” while the final value would be much lower due to the subsequent market correction. Infact, in this scenario, lump sum would perform much better than SIP as it would not be subjected to the “negative effects of higher rupee cost averaging”.

Therefore it has been proved beyond doubt that SIP might not always be a best investment route. So, not let us move forward and examine when would it be ideal to invest through SIP or when just buy it lump sum.

Market Condition
Superior Investment Option
Rising or Bull Market
Lump sum
Since the investor buys lump sum at a lower price rather than “averaging upwards” through the SIP route
Falling or Bear Market
Neither of the two
Simply because in a bear market an investor is going to lose money in equities – whether SIP or lump sum
Sideways Market
Indifferent between the two
Both will lead to somewhat similar results since there is neither any benefit nor suffering due to using either of the methods
Market in Median range, corrects downwards and then moves up

SIP would in most probabilities perform well because the investor will get the assistance of the intermediate correction to “lower his average cost”

Market in Median range, moves upwards and then moves down

Lump sum
Lump sum should in most likelihoods perform better since the investor will not average higher

Common misconceptions about SIPs

Misconception: SIPs generate higher return than lump sum investment
Truth: As explained earlier, this is just a misconnection disseminated by vested interests like mutual funds and their distributors. SIP can be as good or as bad as lump sum – in all depends on which market condition you are in.

Misconception: SIPs always generate positive return over the long term
Truth: There can be nothing further away from truth. This statement is made under the assumption that equity markets always go up over the long term. If for whatever reasons equity markets don’t go up over the long term then there is no way in which SIP would be able to generate positive return. And if equity markets indeed always go up over the long term, then whether SIP or lump sum or any other method, the investor will always get positive return.

Misconception: SIP would always give positive return because of “rupee cost averaging”
Truth: This is a stupid statement. Rupee cost averaging can work in the investor’s favour or against him, depending on which market condition it is. If it’s a bull market then rupee cost averaging actually works against the investor and vice versa.


SIP works on the principle of regular investments and brings the power of compounding to your forth. It removes tensions and uncertainty from your investment plan by making it a mechanical boring process. It inculcates the habit of regular savings and does not encourage timing and speculation in the markets. All these are correct and accepted facts. But, don’t forget that SIP is just another method of investing, it is a vehicle not the final destination – it may pass through straight road or bumpy roads – it may lead you to your destination is a lesser or sometimes higher time frame – and sometimes it may even not lead you to your destination by derailing your plan. SIP is just a method of getting on to the investment vehicle to reach your destination – if the vehicle you choose is incorrect – whichever method you may get in- there is less likelihood of you reaching your destination. Therefore, the next time when a mutual fund or distributor or financial planner advises you that SIPs are the safest route to invest in equities then remember that they are not telling lies – it is safest route but not for you the investor but for their own selves.