Systematic Investment Plans (SIPs) have gained a lot of popularity over the last few years. They are heralded as an ideal investment method for small, mid and large-cap investors.
However, there has been some confusion about SIP mutual funds with respect to the market effect on returns. Most financial advisors advocate SIP Investment as it frees you from the task of timing the market while also acting as a solid long-term investment.
What is SIP?
SIP or Systematic Investment Plans allow you to invest a fixed amount of money in regular time intervals in mutual funds, generally equity mutual fund schemes. With SIP, a fixed amount of money is auto-debited from investor’s account in regular intervals which helps to maintain the habit of savings in investors.
Why should you invest in SIP?
Here are some reasons why investments through SIPs are a good choice:
- One must invest in SIPs because they allow you to inculcate financial discipline in your investments.
- SIPs help you achieve your identified financial goals in a systematic, planned, and consistent manner.
- The funds are invested automatically in the selected scheme at regular intervals of time, allowing one to monitor the progress with ease and plan accordingly.
- Through SIPs you can make a regular investment without having to worry about index level, market fluctuations, and other factors.
- SIPs lend the benefits of rupee cost averaging and compounding to the investor, thereby mitigating heavy losses and generating better returns. Read on to find out how.
How is SIP beneficial?
When you are investing in SIP, you have two primary benefits:
- You can benefit from rupee cost averaging and enjoy maximum benefits: If you have a fixed long term SIP goal, you get more number of units when the market is low and lesser units when the market is high. This lets you average out the mutual fund unit purchase costs.
- Compounding: For a long-term investment, your earnings begin to compound. Over time, your earnings will grow at a faster rate, as your original invested amount will have grown. The compounding effect calculates earnings based on the value of your investment on that day, rather than your original invested amount.. This means that even with small, regular investments, you are able to build a large corpus for yourself.
SIP Investments are an all season Investment option
A lump sum investment in a market that is on its all-time high is extremely risky. However, with a Systematic Investment Plan and a long-term investment horizon, you are protected from market fluctuations and stand to benefit in the long run.
For all mutual fund investors, timing the market and their investments is of crucial importance. Timing investments right means that you enjoy the benefits of your scheme. On the other hand, when the timing of your investment goes wrong, it can adversely affect the returns.
SIP, as advised by most financial experts, provide you with good results with regular investments without having to monitor them on a regular basis.
SIP in the three common Market Scenarios
When it comes to any mutual fund investment, there can be three scenarios: a rising market, a falling market, and a range bound market. Let us see how SIPs fare in these scenarios:
Rising market
When the market is going further up, you may wonder if you should continue your SIP investment or stop it. This is when mutual fund units are bought at a higher price. While this may seem illogical, you must ask yourself what your next step will be. Will you stop the SIP, accumulate more money, and then invest it in a lump sum when the market falls?
If so, how much will the market fall and when will it fall? Can you be sure that it will fall below the current level? This is almost impossible to predict. However, when you invest in SIP in a rising market, every installment will be provided at a price that is lesser than its peak in a rising market (also called a bull market). So, the investor will always benefit from making a regular investments in a SIP.
Even when you buy mutual fund units at a higher price with SIP, you will be able to earn a profit if the current price is higher than the price at the time of purchase.
Falling market
The next scenario is when there is a market correction or when the market begins to fall. In this case, you will buy your mutual fund investments at a lower price with every installment. However, the value of this investment reduces when the market falls.
There are many market movements that are temporary and counter trend. This includes a falling market (also known as a bear market) or a rising market (also known as a bull market). It is very hard to spot these movements and is harder to act upon them. This will lead to longer waiting periods for making an investment. You will also possibly lose a great investment opportunity during that time because, the longer you remain invested in equity, the more likely you are to benefit from the effects of compounding.
If you are an existing SIP investor, you can actually benefit from this correction. You will be able to buy units at very low costs in case of a bear market. You will notice that market movement between the movement in a direction that you wish for and the timing is very significant. So, when you continue with your SIP investment, you stand to benefit from the Rupee Cost Averaging.
Range bound market
A range bound market holds good for a very short period of time. Eventually, the market will begin to either rise or fall. Since the equity market is so volatile, SIP investments can actually bring you great returns. The Rupee Cost Averaging on the price of purchase of your mutual fund units helps you get great returns. This stands true when you have a long term investment horizon.
Case Study
Let us take an example of an investor who invests Rs.5000 each month irrespective of market condition.
| Diversified Equity Funds | ||
| 5 year (Rs.) | 10 year (Rs.) | |
| Invested Value | 3,00,000 | 6,00,000 |
| Final Value | 4,53,884 | 12,18,669 |
| IRR | 16.6% | 13.58% |
| Large Cap Funds | ||
| 5 year (Rs.) | 10 year (Rs.) | |
| Invested Amount | 3,00,000 | 6,00,000 |
| Final Value | 4,33,279 | 11,53,612 |
| IRR | 14.7% | 12.5% |
| Small and Midcap Funds | ||
| 5 year (Rs.) | 10 year (Rs.) | |
| Invested Amount | 3,00,000 | 6,00,000 |
| Final Value | 5,41,262 | 16,15,432 |
| IRR | 23.8% | 18.82% |
Note: The IRR values are based on average values of returns for each fund category.
Conclusion
SIP investments work on the basic principle that helps to accumulate wealth with disciplined investment over a long-term horizon. It is a good idea to invest at an average price over a long term instead of best price in trying to time the market, which is next to, impossible. This scheme takes time to generate wealth but is not affected by any dips and rises in the market, making it the perfect all-season investment option