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SIP maths vs psychology

Unlike many other walks of life, psychology beats maths hands down when it comes to investing

SIP maths vs psychology

There seems to be a persistent and loudly expressed belief among some people that investing through an SIP is useless. The most frequently expressed opinion is that when you have been investing for a long period, then the volatility of your holdings is practically equal whether you have invested through an SIP or in a lump sum. There seem to be a number of blogs, Facebook posts and opinions floating around on social media expressing this. There are a number of mutual fund distributors too, who try to convince their clients of this, for reasons that are not hard to guess. The conclusion that is generally drawn is that SIPs are just a sales trick and that there is nothing useful to be derived from investing through one.

This accusation, if I can call it that, is completely mistaken and yet, it is based on a truth. In fact, that is what makes it all the more dangerous. It's hardly a great discovery that the value of an SIP investment into a fund changes by the same proportion that a lump sum investment does. This is hardly rocket science. If you have Rs 1 lakh accumulated in a fund and it's NAV falls by 10 percent, then the value is going to be Rs 90,000 regardless of whether you invested in a lump sum or SIP.

A further twist to this claim is that over long periods of time, the annualised rate of return from SIP investing is similar to what you would have got had you invested in a lump sum. This is a claim which depends largely on what starting and ending point you choose. Mathematically, the longer the total period of an investment, the larger the share in it of the returns that have been generated along the way and the lower the share of the original investment. Since the cost averaging effect acts only on the original investment, its impact on total return declines gradually as time goes by. If you are trying to prove a point and choose your period carefully, you can claim that the SIP advantage is not all that it is said to be.

All this anti-SIP propaganda completely misses the point (perhaps deliberately) when it's based on the idea that the cost averaging effect is the only, or even the major reason for investing through an SIP. I'll illustrate what I mean by telling you a story from the 80s and early 90s. I had a friend, much older than me, who had a business of academic books in Old Delhi, in a narrow street called Nai Sarak which is Delhi's center for this business. Every afternoon, after he had had his lunch he would set off on a walk through the neighbourhood in order to settle his food and chat with other shopkeepers. His walk would take him past the local post office and if he had Rs 500 to spare in his pocket, which he did on most days, he would saunter in and buy an Indira Vikas Patra with that money. The IVP was a government savings scheme which was based on bearer certificates so was ideal for those who had a cash income. In fact, it was designed to allow the government to borrow black money.

I would say that this is a perfect example of what SIP investing is actually about. SIP is really not about maths but psychology. It fits your income pattern and makes it likely that once you start it, you will not stop. Walking into the post office every day was the perfect SIP for my late friend because it fitted his income pattern and his habits. Whether SIP has a better IRR than lump sum investing or not is an academic question fit for academics to write about.

Those of us who have a monthly salary do not have the option of investing a lump sum. The first requirement for getting returns in investing is that you must invest and keep investing a regular portion of your income and not get tempted to do something else with that amount. The best way to do that for salary earners is a regular SIP. That's all there is to it.