Do Systematic Investment Plans (SIPs) really work? This may seem like a surprising question to ask after SIPs have been around for over a decade, have been sold to lakhs of first-time investors and already account for a reported 9.5 million folios in the Indian mutual fund industry.
But this is a live topic of debate between investors, Independent Financial Advisers and market watchers currently. Most of the discussions swirl around two or three recent data points. One, SIP returns in most categories of equity funds are in negative territory for the last one year. Two, SIP returns for many equity funds for a three-year time frame are also lower than lumpsum returns. Three, SIPs in some funds have underperformed fixed deposits even for really long periods of five or ten years.
This has led to some smart folks coming up with suggestions to improve upon the current design of SIPs. For instance, why not further split up and spread your SIPs over different dates of the month? Why not try out value averaging rather than cost averaging?
In our view, discussions of this nature add an unnecessary dose of complexity to a device that was meant essentially to simplify equity investing. So we decided to de-mystify the concept of SIPs, by addressing the common reader queries that have poured in. Read on...
No matter what you have been told, a SIP does not protect you against equity market losses. All it does is to make sure that your investments in equity funds are well spread out over a period of time, at different market levels, so that you don't make a big loss because you invested a lumpsum at a market peak.
Here is how SIPs score over lumpsum investments. We all know that the equity markets don't make their returns in a steady and predictable manner. They move up, move down or wriggle sideways for a long spell. So if you are investing a large lumpsum, if you are lucky enough to get in at low market levels and exit at highs, your returns would be maximised. But if you are unlucky, you may also end up investing in at a market peak and watch your investments go downhill over the next few years. Not many investors would be able to stomach such a situation. They may end up exiting their investment at the wrong time (a market low) and losing money for good.
Just consider the fate of investors who bet big lumpsums in equity funds when the Sensex was at 21,000 in February 2008, at 21100 in November 2010, or even 30,000 in March 2015. As the Sensex tanked to much lower levels in the subsequent months (sub-8000 in October 2008, 15100 in December 2011 and 22400 in February 2016), these investors are sure to have lost a packet and would have wished they had invested at a better time.
It is to avoid such regret that SIPs were invented. By spreading out your investment over many months and hopefully, many different Sensex levels, they ensure that all your savings don't go into the market at just one Sensex level.
Now, SIP investments too will make losses, if the market declined steadily after you begin your investments. But because SIPs help you invest in smaller instalments and spread them out over time, you get to average your investments at lower levels, in the hope that, when stock prices bounce back, those cheaper investments will pay off. If you take stock of your SIP returns over just one market phase, particularly a bear phase, the investment will show a loss.
In India, a typical market cycle lasts five-six years (from bull market to bear market, and back again). That's why it is necessary to evaluate SIP returns on your equity funds over five years, rather than short periods like one year.
Blame it on market behaviour in the last three years. SIP investing is designed to max out your returns when you get off the starting block at a market high, keep investing through a decline and then see the markets recovering to scale new highs. It doesn't work well when the markets don't stick to this script.
There are two types of market scenarios where a SIP investment will earn lower returns than a lumpsum investment.
One is a steadily rising market. Imagine that a rich uncle left you ₹10 lakh in his will in the month of March 2009, just when there was mayhem in the stock markets and the Sensex was languishing at a multi-year low of 9000 points. Now, had you been brave enough to sink all of that money into equities in that month alone, you would today be sitting on at least ₹28 lakh (assuming index investing). But if you did a two-year SIP instead, you would have invested small instalments as the Sensex rose all the way from 9,000 in March 2009 to 19,000 in February 2011. Essentially, you have been buying into stocks as they got more and more expensive. This would have left you with a lower sum of ₹15.6 lakh today.
The other is when markets behave like a bell curve - they rise first and then tank. This is exactly what has happened in the last three years. An investor who began his SIP in May 2013 would have started at a Sensex level of 19,700 or so, and kept putting in monthly instalments as the Sensex rose all the way to 30,000 in March 2015. But after making that peak, the index found it difficult to hold on and has fallen to 25,600 now (May 2016). This effectively means that only the SIP instalments you made at less than 25,600 levels are now in-the-money (generating a positive return). The ones that you invested at market levels of 25,600 to 30,000 are making losses, thus pulling down your overall returns. Over time, as markets take off again and scale new peaks, the 3-year investors will find their returns improving. But until then, their returns will be low.
But if we know what kind of markets are best for SIPs, why can't we wait for just the right conditions to begin investing? Well, that calls for Nostradamus-like qualities in predicting the direction of Sensex.
After all, if you knew that the market was going to head only Northward, why would you postpone your investment through a SIP? You will bet your shirt with a lumpsum right away! And if you can predict a big fall ahead, why lose money investing now? You would wait for the bottom and invest then. But as none of us can predict either the sequence or nature of market moves, SIPs help us hedge our bets both ways.
The poor SIP returns over 5 and 10 years are a sure sign that the equity funds you own are underperformers. While SIPs are a good tool to protect your portfolio against adverse market moves, SIPs cannot help you if the funds you have selected for your portfolio are lemons. If the fund you have selected has the habit of consistently lagging its benchmark or peers, its SIP returns will mirror those poor returns.
As you mention, we do have several one-or two-star rated funds in the equity category, which haven't even managed bank deposit returns in the last ten years. In fact, as of May 15th, we see six funds across the Large-cap, Multi-cap and Mid-cap categories that have ten-year SIP returns that are below 7 per cent (measured by internal rate of return). However, you should note that in the same categories, top rated funds have impressive SIP returns of 18-20 per cent.
Now, the difference between top rated funds and the bottom ones is easy to point out with the benefit of hindsight. Hardly anyone could have predicted exactly, ten years ago, which set of funds would end up at the top of the rankings and which would scrape the bottom.
But by regularly tracking your equity funds, (reviewing your portfolio at least once in six months) and replacing the funds which chronically underperform their benchmarks and category, you would have been able to effect mid-way corrections in your portfolio for better returns.
In fact, one of the real dangers of SIP investing is that you can end up putting a lot of money into a badly performing fund. Unlike lumpsum investments, where you may put a lot of thought into fund selection, SIPs essentially put your investments on auto-pilot. Without your realising it, they keep pushing more and more money from your earnings into a fund month-after-month.
This is why it is even more important for SIP investors to take stock of your funds' performance at regular intervals. Unless you do this and make mid-way corrections to your portfolio, you may find that a dud fund has absorbed a great deal of your hard-earned savings.
So if you are a SIP investor, don't forget to review your portfolio once in every six months. If a fund you own is trailing its benchmark for 2 years running or its category for 3 years, stop your SIPs. Invest in a better performer.
SIPs can and should be stopped in three circumstances. One, if you realise that you have chosen a wrong asset class or wrong fund for your portfolio, carrying on with the SIP even after you know it, will only compound your losses. Therefore, if you find that you started a SIP without understanding the risks in the underlying fund (many investors even think that SIPs aren't mutual funds!), you should stop the SIP as soon as you can and switch to a safer investment. As explained above, SIPs can commit a lot of your money to a single fund without you even realising it.
Two, if a fund that you are investing in is a chronic underperformer (versus its benchmark or category), you should stop SIPs in that fund and switch to a better-rated one. Also remember to redeem the sums you have already accumulated in the fund. Allowing legacy investments to lie in a bad fund can carry a big opportunity loss over the long-term.
Finally, stop your SIPs in an equity fund as you get closer to your financial goal. Given that equity markets can suffer sudden setbacks or losses over short time frames of one to three years, it is advisable to switch from equity investments into debt or cash at least three years ahead of an important financial goal, be it your child's education or your own retirement. That holds true for SIP investments too. If in doubt about market conditions, do use the Systematic Withdrawal route to redeem your units, so that your terminal investment value doesn't impacted by market timing.
Many investors carry the erroneous perception that SIPs once started cannot be stopped. That's not true. Mutual fund houses allow you to revoke SIP orders earlier placed, either through an advisor or through the direct mode.
Having said all this, advisors ask you not to panic and stop SIPs during adverse market conditions. Many investors are full of enthusiasm for equity investing when markets are riding high, but are quick to lose their motivation when the markets enter a bear phase. It is to discourage such behaviour that advisors ask you to continue with your SIPs through ups and downs of the market.
There is no ideal date for a SIP. Changing your SIP dates would only work if there was a clear pattern in the markets that played out like clockwork every month (Imagine if the Sensex began each month at a high on 1st, tanked 10 per cent by 15th and rose 20 per cent by 30th!). But we all know that market moves are a complete random walk.
Let's take a live example of Franklin India Prima Fund. An investor who invested ₹10,000 in SIPs on May 1st of every month between 2011 and 2016 in this fund would have ₹11.3 lakh accumulated in his account, against a cumulative cost of ₹6.1 lakh. That's a 25 per cent annualised return. Had he changed the SIP date to 10th of each month, his investment value would be ₹11.28 lakh, a 25.1 per cent return. If he changed that to 30th of each month, the return would be identical. This example tells you that there's no point in sweating it out over the date of your SIPs. Just pick a date after you receive your monthly salary credit, so that you will have a sufficient balance in your account.
Trying to average out your monthly instalments by splitting your SIPs into weekly instalments and trickling it into the fund in smaller doses, doesn't have a big payoff either. A weekly SIP in Franklin India Prima Fund between May 2011 and May 2016 has given you a 25.2 per cent return a measly 10 basis points more than the monthly SIP. And there would also be times when the monthly SIP outperforms the weekly one.
Having started a SIP for a tension-free experience, why fret over adverse market moves or second-guess it? Your very intention in taking the SIP route is to avoid worrying about timing. So pick any date and just stick with it.
One of the criticisms that seasoned investors have against Systematic Investment Plans (SIPs) is that they don't let you invest more into equities when the markets are down. They therefore suggest that investors should use 'value averaging' to make monthly investments in equity funds, rather than plain-vanilla SIPs.
What's the difference? Well, as you probably know, a normal SIP commits you to investing equal monthly instalments in an equity fund. The amount that you invest remains the same irrespective of what the market does. If the market tanks big-time after you begin your investment, SIPs make sure that you keep putting in ₹5000 every month without getting spooked by the falling markets and stopping your investment.
Now, some advisers may tell you that SIPs help with 'cost averaging' because as the NAV falls, you get more units of the fund. Conversely if the market rises you get fewer units. While that may be mathematically right, getting more units doesn't really help you earn higher returns. What really matters to you as an investor is the value of your investments in the fund and how it grows over time. The underlying units you receive really don't matter in deciding your portfolio value.
Value averaging, which some mutual fund houses offer as an alternative, helps you do what ordinary SIPs don't. They reduce the size of your monthly instalment when the markets are rising, and increase the instalment when markets are falling. Typically when you sign up for Value SIPs, the fund house will ask you to specify both a lower and upper limit for your monthly investment.
Let's say you set ₹1000 as your lower limit and ₹50,000 as your higher limit. Now, based on the monthly movements of the index, the fund house will debit different amounts from your bank account each month, based on whether the market has gained or lost value in the preceding month. So, in a rising market your SIP value may go down to ₹1000. In a falling one, it may go up to as high as ₹50,000.
By varying your SIP instalments, value averaging makes sure that you do the exact opposite of what you are behaviourally hard-wired to do - buying in a bull market and selling in a bear market! While value averaging is a theoretically sound concept, applying it practise can be quite difficult for investors.
If you are a regular income earner, you may have trouble managing the huge and unexpected variations in the debits from your bank account that value averaging requires. In a downward trending market, you may be forced to fork out ₹50,000 (in the above example) for many months running. And in a rising market, your investments may fall to almost nothing for many continuous months. This can play havoc with your cash flows.
This variability in instalments can also make it hard for you to keep track of your investment and its performance.
The formula that the fund houses uses to set the investment levels in a Value SIP is also important. These are generally based on back-tested formulae. But if the markets do not behave as they have done in the past, your value averaging strategy may not work effectively.
Overall, if you want to keep it simple, normal SIPs should be your choice rather than value averaging.