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SIPs: The antidote to market volatility

While market ups and downs intimidate investors, SIPs help you average your cost over a period of time

SIPs: The antidote to market volatility

Evolution happens in stages. From the dominance of closed-end plans to the popularity of open-end ones; from the availability of only regular plans to the emergence of direct plans; from an era of high commissions to low commissions; from the dominance of active funds to the emergence of passive ones - the mutual fund space in India has evolved over the years. The idea of SIPs has also taken off. Many investors today understand that SIPs are a better way to invest in equities as compared to lump sums.

SIPs aren't magical; they are just a systematic way to invest. By investing periodically, ideally monthly, you become disciplined about investing. More than discipline, SIPs help equity investors navigate market volatility. Volatility is an inherent part of the market. It can't be done away with. Hence, the need is for a mechanism that can counter it. That mechanism is SIPs. When you invest periodically over the long term, you get to invest both at market highs and lows. When you invest at a market high, your SIP will fetch you less units. When you invest at a market low, your SIP will fetch you more units. This averages your overall investment cost.

Markets are unpredictable. Nobody can tell with certainty when they will rise or fall. If you wait for the right time to invest in the market, it may never arrive. A rally may go on for years and a slump can continue for months. SIPs help you naturally get rid of the dilemma of figuring out when to invest. They also help you overcome your inherent biases that are counterproductive to your investment outcome. For instance, many investors stop their SIPs when the markets begin to fall, fearing that they will lose money. Also, many investors start their SIPs in a rallying market because they don't want to miss the bull run.

Keep it simple
For SIPs to work in your favour, you must keep them simple. Today there are many variants of SIPs available. For instance, one type of SIP lets you keep your SIP amount variable. While it's a convenient option to have, it could compromise your discipline. This option opens a window for the investor to direct money to some frivolous expenditure at the cost of accumulating money for the long term.

Yet another variant of SIP allows you to invest more or less depending upon a market level. If you understand the market, you can invest more when the market is down and invest less when it's rallying. This idea appears ingenious at the outset but has its own problems. For instance, it can result in a diminished corpus if the market keeps rallying over many years. Since India is a developing high-growth economy, it's natural for the stock market to show extended rallies and shorter periods of slump.

SIPs are best kept simple. Don't innovate with them to increase your returns. Chances are you will get just the opposite result: diminished returns with operational hassles. Go for the monthly option. It's suitable for most of us. Research shows that SIP frequency has no meaningful impact on your returns. The strength of SIPs lies in their simplicity.