The easiest way to dilute the magic of SIPs is to make them complex
15-Mar-2018 •Dhirendra Kumar
Systematic Investment Plans (SIPs) work wonderfully in helping investors get great returns from equity based funds. However, one of the big threats to investors' usage of SIPs is the attempt by mutual funds to fine tune and optimise SIPs. Sounds weird, but it's true. Let's see how.
Earlier I had written how Systematic Investment Plans (SIPs) were the best feature of mutual fund investing. In SIPs, you invest a regular amount in a fund, typically, an equity fund although SIPs are available for practically every fund. That's all you have to do--maths and psychology take care of the rest!
I had pointed out two important ways in which SIPs help you save more as well as get more returns. First, there's the maths. When you invest a fixed sum regularly you get allocated more units when the markets are low. It's like buying anything else--for the same amount of money, you will get more when the price is low. However, when you eventually sell it, each unit gets you the same price. This enhances your returns.
Second, is the psychology. When the markets turn downwards, many investors don't invest, even though that is the best time to invest. They could be scared of further drops, and are waiting to invest after the markets have reached the bottom. The opposite is also true. When the markets are too high, they don't invest as they wait for the markets to dip. Recent months have seen a lot of behaviour like this. Obviously, these people are now torn between regret and stubbornly waiting for that dip to appear.
It so happens that SIP investors tend to be immune to such behaviour. Whether the markets rise or fall, SIPs continue simply because they are automatic and it takes some effort to stop them. Sooner or later, as the the markets go up, the value of the investments go up and the investors start making good money. This teaches them the value of not stopping their SIPs in response to market conditions. This is the beginning of a virtuous cycle, creating a new generation of investors who understand the value of regular investing.
The combined impact of the maths and the psychology is absolutely amazing. Here are some numbers from a little experiment that I quoted earlier. I selected four equity funds that are old enough and calculated what would have happened if one continued with a small Rs 5,000 a month SIP for twenty years. This yielded Rs 1.29 crore, Rs 1.85 crore, Rs 1.21 crore, and Rs 2.05 crore for the four funds. Do note that the investment in each case was a mere Rs 12 lakh (Rs 5000 a month for 20 years).
However, it's very easy to sabotage this, and that's something that many mutual funds are trying to do actively. They are doing this by promoting the idea that a plain and simple SIP is not good enough and that investors must do something more, some kind of an embellishment to the SIP to make it better.
Generally speaking, all this 'enhanced' (in reality, degraded) SIPs are a form of market timing. That means they try to modulate the investment based on market conditions. These tricks are offered by many AMCs and even some distributors. One common trick is to increase or decrease the SIP based on index levels or the valuation of the markets. Similarly, another trick is to have an SIP which flows into a debt fund when the market conditions are supposedly more suitable for such funds. At a later date, based on some set of rules, the money flow is shifted from the debt fund to an equity fund. There are other plans which vary the date of the investment based on similar rules.
Each of these is offered by the AMC or the distributor to enhance returns. Each is sold with some sort of a back calculation that shows that it is a superior way of investing. However, they miss the point entirely. The real value of SIPs lie in the simplicity, and the hand-off approach that it teaches the investor. The message of these supposedly enhanced SIPs is the opposite. They promote the idea that investing in mutual funds is a complex activity that requires constant attention and adjustment. They ultimately lead the investor to believe in the very opposite of the SIP approach to investing.
About the only adjustment that one should make to one's SIPs is to increase the amount of the monthly investments as one's income increases. That's a natural increase, and the only one that makes sense. SIP is the most wonderful investment technique which is based on simplicity. Avoiding complexity is an important goal, one that investors should not lose sight of!