SIP-ping liberates us from the need to be antsy about market’s ups and downs, and our calculator helps further
The slump in the economy and its impact on the downcast equity markets have made staid investors rethink about staying invested.
But amidst the gloom and doom, knowing a little more about the popular investing route of systematic investment plans (SIPs) could shed some light on why they still make sense.
SIPs are often the method the average retail investor takes to invest in equities. SIPs are not synonyms for mutual funds (MFs) but are a way of investing in them.
An SIP allows us to invest an amount, set by us, at regular intervals (monthly, quarterly, etc.) in a fund. The amount is auto-debited from our designated bank in case of MFs, and from our preloaded demat accounts for single stocks and exchange traded funds (ETFs). The money buys us a number of the scheme’s (or stock’s) units, as dictated by its unit/market price that day.
Infact, SIPs can be a strategy for investing in other baskets or funds comprising numerous securities such as ETFs. SIPs in single stocks are also a possibility, though that would require us to be more mindful of the workings of the market. Debt funds, in both MFs and ETFs, can also be subscribed through SIPs (for ETF SIPs, refer our blog).
We can start with as little as Rs 500 a month with an SIP. The Association of Mutual Funds (Amfi) puts the average SIP size at about Rs 3,000 an account, with 954,000 accounts opened each month in the current financial year (FY2019-20).
Other Ways Into Money Markets
SIPs, of course, are not the only way to the stock markets. We may invest a lump sum in a fund or we may buy individual shares or debt securities straight from the market, or instruct our brokers with a demat account to buy at regular intervals.
Circling back to why SIPs are relevant in this market condition, and not only in an optimistic environment, we need to understand the principle behind it. SIPs remove the angst-ridden need for timing the market.
In investor parlance, timing the market means buying ourselves assets when the market is at its lowest, and essentially avoiding shelling out more money when the prices are at their highest. This ensures we spend less but gain the most when there is an uptick in value. However, with a timing-ignorant but consistent approach we won't be worse off.
For an SIP investor, there should be no reason to panic unlike those brandishing a lump sum amount. With SIPs, we are investing in increments and at regular intervals.
The installments buy us units of our chosen scheme at different prices (the unit price is called Net Asset Value or Nav). Higher price would mean we buy less units with that installment and low prices gets us more units.
With cyclical ups and downs, over time, the good (low price) averages the bad (high price) out and leaves our investment corpus to reap the benefits of returns on the fund. There is, of course, a name for it -- rupee cost averaging.
Rupee Cost Averaging
Rupee cost averaging explains how our investment cost (the money we spend to earn returns) behaves when we invest at regular intervals. When we keep buying units of a particular fund regularly, say monthly, we get the chance to experience all the market phases -- both the bull and the bear runs.
As a result, our average investment cost remains reasonable for those of us who don't want to get into the cryptic practice of timing the market. With small amounts spent at regular intervals, there would be times when we will catch the lowest price of the fund, the best scenario, and this will balance out the times we will end up paying the highest price on the fund.
A one-off lump sum investment won't afford us the boon of rupee cost averaging. Of course, we have to consider a sizeable period of at least five years to start benefiting from it with an SIP.
Source: Tavaga Research
The above is an illustrative chart on how rupee cost averaging works for us, the investors -- buying different units at different prices over a year. It evens out the blows from high unit prices by getting us more units when the price is low.
Using SIPs, we can hit the middle ground, on both total units and value of investment, between a bad and a good market, as the following chart captures:-
Source: Tavaga Research
In the present volatility, as the indices head south, withdrawing from the markets or stopping an SIP defeats the purpose. A move akin to timing the market, it gives in to undue panic and overlooks the benefit of rupee cost averaging.
Data sourced from Passivefunds.in shows, in this blog, over a period of 282 months, from 1995 to 2019, the portfolio which did not time market to not have done too badly, driving home the fact that we don’t have to fret over when to invest.
SIPs are also mighty good at instilling discipline, a trait every investor should hone. The auto-debit of an SIP hides away a part of our money from us at regular intervals. Now, any investor with an iota of self-discipline will tell us why that is such a good idea. Else, let this blog serve as a reminder that hiding money from ourselves is a winning way to discipline even the most errant investor.
By removing the need for triggers to invest, be it for that elusive ‘right time’ or for a windfall lump sum, SIPs nudge us towards putting our earnings away from our spending selves, and in places where they work to earn more.
Factors Deciding SIP Amount
The money we set down for an SIP should be governed by our financial goals, which are fed by our larger life goals as this blog tells.
Everything from the current cost of each of our financial goals, years till their achievement, an estimate of average inflation, and the expected rate of return on the instrument we choose for an SIP should go towards informing the amount we pay. Of course, an SIP calculator helps to make the task easier for us.
Increasing the SIP amount in increments every year, perhaps in line with the increase in our income, is recommended. The practice brings us closer to our financial goals, as it keeps pace with inflation.
How to start investing with SIP
Dates don't matter
Just as we don't have to fuss over timing the money markets with an SIP, we don't have to worry about timing our auto-debit. As long as we have funds (and this could be the only guide for setting a date, say, a day after pay day for many of us), the SIP date does not matter.
Missing an installment
If we miss an SIP swipe due to insufficient funds in the designated bank account, either due to financial constraints or because we forgot to transfer from some other account, there is no penalty from the fund house. It would set us back in our efforts to reach our financial goals as a month’s worth of units would be lost.
However, we will have to be mindful of the bank’s charges on a failed auto-debit in its ECS (electronic clearance service).
But if we miss our SIP payments for three consecutive turns, then the fund houses usually cancel our SIP and stop debiting our account for investment. We would have to reapply to get back in.
How not to miss an SIP payment
E-reminders - Opting for reminders on email and our mobile phones can prevent us from forgetting if funds are enough for our SIP. We can check with the timely reminders.
Standing instructions - If we are juggling between more than once account, especially one for SIP and another for salary, standing instructions could help an auto-debit from the source of funds to the investment account.
Salvaging missed turns
While there are no penalties from the fund houses when we miss a payment, we stare at a missed opportunity. To compensate, there are a few ways to keep in mind.
There are options to buy fund units ad hoc online or through offline channels. A missed SIP purchase could be compensated by opting to manually buy units.
We could also avail of the facility with some funds to invest a lump sum with an ongoing SIP.
But then again, the point of an SIP is to not having to get antsy about our equities or money market investment but be secure in its regularity. So, acting on missed SIP should ideally be about promising ourselves not to miss one again.
There might be times when we would still want to cancel our SIP. We could be relocating abroad, want to invest somewhere else instead or simply want to change funds to invest in.
Cancelling an SIP requires us to inform the AMC or our agent. It can be done online or through offline forms with details of the folio number, SIP account, bank account, SIP amount etc. Cancellation might take a month to process.
In tandem, we will need to inform our bank to stop the ECS or auto-debit, as it will stop payments even if there is a delay in processing at the AMC’s.
We can also temporarily stop payment if the need arises by instructing our bank to stall auto-debit. But again, after three missed SIPs, the fund house will cancel our arrangement.
Some fund houses let us pause the SIP withdrawal but it is for a limited period of time and can be done only once in our SIP tenure.
However, experts advocate staying invested for at least five years. If we invest for less than five years, even with an SIP, the chances of negative returns are higher as our capital may erode with the goings-on in the money markets.
But if we stay invested for more than six years, ideally even 10-15 years, we increase the probability of catching the improvement in market sentiments and earning good returns to compensate for any intervening slumps in the market.
This chart shows how ETF returns increase considerably with time, across funds:-
Source: Tavaga Research
Types of SIP
There are different SIP features such as flexible, top-up, perpetual and trigger. We detail the three best suited to the average investor, apart from the regular SIP discussed throughout this blog:-
Top-up SIP: This is an option which can arm us better to fight inflation. We can increase our SIP amount yearly with a top-up SIP, as our income increases.
Flexible SIP: This option allows us to increase or decrease the SIP amount with predetermined market conditions, say the unit price changing by a specific percentage or a particular market valuation.
Perpetual SIP: If we do not mention an end date in our SIP mandate when signing up to denote a fixed tenure, it is considered as a perpetual SIP. It leaves the decision for when we want to redeem for later, if we feel our financial goals are fluid and need more time.
What to do with a lump sum?
If any of us are fortunate enough to come into a lump sum for investment, it might still make sense to look at the SIP route.
For all the reasons we have mentioned so far, SIPs accumulate wealth in a more reassuring manner than one-time investments.
We might dread not being able to buy more units when the market prices rise with an SIP but that is a misplaced fear. A lump sum higher than our SIP might buy us more units at that time, but as a sustained strategy, it is more volatile for the average investor.
Comparisons between lump sum and SIP for just a year’s worth of investment might yield a result favouring the former. It goes on to show with an SIP, we will be better off looking at a sustained, long-term plan of 10-15 years. Lump sums can work for the savvy in the short term.
So, we can put our lump sum in our SIP bank account and let the auto-debits do their work, staggering our entry at different unit prices.
Amfi reckons there are currently 27.8 million SIP accounts, opened by investors. The SIP contributions have only increased in leaps and bounds over the past few years as shown in the chart:-
Source: Tavaga Research
At the end of it all, investing well hinges on being able to make the most of the compounding effect. Returns on our investments become a part of that very investment, as we stay invested, and earn us further returns. Turn to this blog to know more about the magic of compounding.
With an SIP, we will be comfortably on our way to enjoy the fruits of compounding.
Treating SIP as a savings tool just as much as it is an investment route can prove to be a useful reminder if we ever think of discontinuing.
Many of us, including those at the start of our careers, earn enough to invest. But we just don't save enough to do so. SIPs help us save and invest, a twin bonanza.