Saturday, July 24, 2010

SIP: Best investment policy for all

Zealous advertising by asset management companies leads to some concepts and products being misunderstood by customers. They come up with unusual requests, which put service providers in a spot.
I market mutual fund products. Recently, a client came up to me and asked for an application form for systematic investment plan (SIP). I replied, "Wonderful, which scheme you want to start an SIP for?"
He got a bit agitated and looked at me with disgust. He gave a supercilious guffaw and said, "What do you mean which scheme? Don't you know SIP is a fund which has given stupendous returns on your investments."
It took a bit of convincing to reassure him about my professional competency. He backed down a bit and listened to my take on SIP.

An SIP is an old tried and tested method of investing. It is not a miraculous investment scheme that gives outstanding returns.

SIP is a method of investing a fixed /regular sum every month or every quarter. The investment can be in the scheme of your choice as most mutual funds give you this facility for their schemes. In other words, instead of investing lumpsum in one scheme you invest a smaller fixed amount every month or every quarter.

For example: If your scheme of choice is, say, HDFC Top 200 or DSPML TIGER and you want to invest Rs 1,00,000 in it. Instead of issuing a cheque of Rs100,000 at one go, invest Rs 5000 every month for 20 months. This is systematic investment planning.

The biggest plus which SIP provides you with is regular disciplined savings. I have observed that the urban yuppie is living an EMI-supported lifestyle Homes, cars, timeshare memberships for holidays, laptops, all sorts of consumer durables are bought on EMIs, which eat into their salaries. It is virtually impossible to accumulate a decent sum which can be invested at one go. An SIP gives them the benefit of piecemeal investing of small sums.

Every month, like all other EMIs, this also gets deducted from the bank a/c through electronic clearing service, which is convenient. A SIP does not pinch the pocket much if started at an earlier stage. It adds the power of compounding to your savings. An illustration of power of compounding works as under:
Suppose every year you invest Rs 60,000 at 12 per cent per annum. After 30 years it will add up to Rs 1.60 crore (Rs 16 million). If  the savings were started 5 years later the kitty accumulated would be lower by Rs 90 lakh (Rs 9 million) to just Rs 89 lakh (Rs 8.9 million). Just an early start of five years, that is, an additional Rs 3 lakh (Rs 300,000) of incremental investment increases your corpus by almost a crore (Rs 10 million). That is the power of compounding.

Want more money to retire comfortably? Start one more SIP, for a higher amount.
SIP facilitates averaging costs over a period of time. Since you are investing the same amount every month or every quarter, the average NAV at which you have acquired the units will be lower.

Let's say, Mr Z invests Rs 5,000 every month  and has started the SIP in September 2006 (Table I).

Table I
Month Amount invested (Rs) NAV (assumed) Units allocated
Sept 06 5,000 10 500
Oct 06 5,000 10.5 476
Nov 06 5,000 9 555
Dec 06 5,000 13 384
Jan 07 5,000 8 625
25,000 2,540

As you can see more units are allotted to Mr Z when the NAV is lower and fewer number of units are allotted when the NAV is higher. The average cost per unit for Mr Z is Rs 25,000/2,540 = 9.85 and the average cost during the same period would work out to (Rs 10+10.5+9+13+8/5=10.1)

Had Mr Z invested his Rs 25,000all at once in September 2006 he would have been allotted 2500 units at the cost of Rs 10. This is assuming a no load structure in both the methods of investing.

Wait, there is a qualification!!. If a SIP is started for a short period or especially during a singular bull run ,it will work against you. Every time you invest it will be at a higher NAV and the units allotted will be lower.
Well, then where is the misunderstanding?

With so many points in its favour, you might believe that one just cannot err with an SIP. That's incorrect. There is a certain way of reading the performance of an SIP vis a vis lumpsum which is explained below. A leading equity scheme has showcased these returns as per the table below:

The table assumes an investment the scheme Rs 1,000 per month. SIP against a lumpsum investment every year for five years, three years & one year, the returns would be as follows (Table II):

Table II
5 years SIP 3 years SIP 1 Year
SIP investments Rs 1,000 p.m Rs 1,000 p.m Rs 1,000 p.m
Total amount invested 60,000 36,000 12,000
Returs (annualized) 54.18% 50.81% 38.53%
On Time investments Rs 12,000 p.a Rs 12,000 p.a Rs 12,000 p.a
Total amount invested 60,000 36,000 12,000
Returns (annualized) 50.60% 43.53% 34.15%

Clearly, the returns earned though an SIP is higher across all periods. But if you notice, returns from a lumpsum investments were not all that bad either. This scheme had also beaten the benchmark whether you invest via an SIP or a lumpsum. (Since the scheme name is not revealed, benchmark becomes irrelevant)

Sometimes, the underperformance is cleverly couched by highlighting the SIP returns only. Returns across other parameters and compared with the benchmark may be poor.

So one must study all the parameters before deciding to invest. Unfortunately if you have chosen a dud scheme to invest systematically in, it will not transform its laggard status and give you poor returns for sure.
An SIP should be treated as what it is, a nice process of investing. The true test of a mutual fund scheme is its ability to beat its peers as well as its benchmark consistently.

The correct approach is to pick out a leading pedigree scheme, a consistent performer in a category, which suits your risk appetite, to systematically invest in.

The writer is head-mutual funds at Derivium Capital & Securities.

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