Like clockwork, every time the equity markets are weak (or are being generally accused of being weak), SIP doubters raise their heads again. In fact, because the total number of SIP investors has grown so fast, the number of doubters is also much larger than in the past. I hope that as time goes by, a higher proportion of mutual fund investors settle down to the concept. But for what is supposed to be a simple (and simplifying) idea, there are still way too many misconceptions about the SIP (Systematic Investment Plan) way of investing.
At Value Research, we get a steady stream of investor emails asking questions that show that for some, SIPs remain misunderstood and misused. Here's a typical one, "The markets are expected to stay oversold because blah blah. Is it wise to hold SIPs in such a period?". This is just one such example. In general, those who have a punter's approach to investing, or spend too much time watching the punting channels on TV, carry over that approach to SIPs, trying to stop and start SIPs by timing the markets.
Back in 2010, when equity-based investments were just recovering from the biggest crash anyone has ever seen, I remember investors claiming that SIPs were no good and that they had barely broken over the preceding years. This was actually not true. However, what had happened was that these were investors who had stopped their SIPs after the crash of 2008, and then restarted after the recovery in 2009. Obviously, their returns had suffered badly.
With smaller degrees of severity, this phenomena repeats itself whenever there's any drop in the equity markets. The basic idea behind SIP is that while the general direction of an equity investment is upwards, it is not possible to reliably predict the actual fluctuations that it may undergo as part of its general trend. Instead of trying to time one's investments, one should regularly invest a constant amount. As time goes by and the investment's NAV or market price fluctuates, this will automatically ensure that when the price was low, you ended up purchasing a larger number of shares or units. Eventually, when you want to redeem your investment, all the units are worth the same price. However, because your SIP meant that you bought a larger number of units whenever the price was low, your returns are higher than they would have been otherwise.
Those are the basics of how it works. However, an investor has to resist sabotaging this. You have to allow it to work by going on investing when the market is low and not try to time it. At one level, SIPs are nothing more than a psychological trick to make you invest when the market is low without having to guess what it will do next.
The underlying issue is that the real problem in saving is not where to invest but to not stop investing. Savers invest in fits and starts and then stop investing when equity markets fall, often because falling equity prices are presented as a crisis in the media. But this makes no sense at all. As a buyer of anything, you should want low prices. So should you as a buyer of equity or equity mutual funds.
There are two goals of SIP investments: One, to ensure that you keep investing regularly. And two, that you do not stop investing when the markets are shaky. To generate great returns, both are equally necessary. Don't sabotage your investments by not sticking to the plan.