SIP’s: Makes Sense, but to Whom?

May 20, 2012

This article was published in The Global Analyst

If you have been investing through advisors, or basing your investment strategy on what you read in stock market magazines, you may probably have heard one or all of the below: 

 

1.  You cannot and should not time the market.

 

2.  You should consider investing regularly (say monthly) so that you can take advantage of             market volatility &

 

3.  Regular investments or Systematic Investment Plans (SIP’s) is easy and flexible and can               inculcate savings habit.

 

To add to the emphasis, imagine you invested lump sum during Jan 2008 or November 2010 when Sensex was at its peak (20,800). At the current level (16,152) your portfolio would be down by 22%. Hence, the case for SIP.

 

Has SIP’s produced superior results to say a Buy and Hold (B&H) strategy? The table below tells it all.

During the last 8 years of analysis, SIP’s outsmarted a B&H strategy only 2 times. The SIP performance is Internal Rate of Return (IRR) method since it involves regular cash flows. For eg., you could assume investing Rs.10,000 every month for the last 3 years. The IRR of your investment at today’s Sensex value (assuming you cash out) would be an annualized return of 2.6%, while a B&H strategy would have yielded an annualized return of 21.5%, a huge difference of around 19% annualized. Except for the last one year and 4 years, the SIP performance lagged the B&H in all other time periods. The table depicts annualized performance; hence the opportunity loss value could be significant for longer time periods.

 

The idea of this analysis is not to critique market timing or discipline in investments. Of course, it is a known fact that it is difficult to “time” the market. Ideally we would like to buy low and sell high, but if we get our timing wrong, we will end up buying high and selling low. But the panacea to this is not systematic investments especially in a volatile asset class like equities as can be seen from the workings. In a consistently rising market, SIP’s can produce average purchase cost lower than the peak value thereby benefiting the investors. However, markets are rarely rising consistently and if they do so, the volatility will be far lower. Markets by nature gyrate between optimism and pessimism and hence produce volatility.

 

The best news for SIP’s lies with the fund houses which can aim for consistent and measured growth in their Assets Under Management (AUM) by enabling you to commit a fixed amount of investment every month. It is good news for them since they earn their fees on the AUM’s and not necessarily on how your investments have performed.

 

Also, once we sign up for a SIP, rarely ever we take the pain of monitoring its performance vis-a-vis a B&H strategy. Hence, SIP’s once started invariably runs its course, which again is music to the ears of fund houses.

 

The only argument in favour of SIP’s is that it is easy on your liquidity, especially if you have a monthly income matching monthly investments. However, given the findings, it may make more sense to commit an SIP to say a Post office Recurring Deposit (RD) or to a debt fund than to an equity fund. 

The author would like to thank Madhusoodhan for data assistance.

 

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