To SIP or Gulp

SIP or Systematic Investment Plan is probably most commonly used acronym in Mutual Fund Industry. People nowadays know about word ‘SIP’ more than ‘Mutual Fund’. Today we will see all basic things about SIP. What is it, why is it, few good points and few not so good things. Hope this article helps to decide to SIP or gulp.

What is SIP

Before we dive into details, lets understand what exactly is SIP. SIP is basically acronym of Systematic Investment Plan phrase. Here investor invests a fixed amount periodically at fixed interval. A common example is monthly SIP. Say you invest in a mutual fund Rs 5000/- on 5th of every month for a year. Here you are doing your investment in systematic manner again and again month after month. Yeah, hence the name Systematic Investment Plan.

What are ingredients to make a SIP

What is needed to make SIP

You need five things to make a Systematic Investment Plan or SIP. Let us take an example to understand. In year 2015, Gurunath and Radhika decided to part ways. Radhika now a single working mother. She needed around 5 Lac for education of her son after 5 years in year 2020. She decides to start SIP in “ICICI Prudential Bluechip Fund” for 5000/- on 7th date of every month for 5 years. So let us see what all ingredients went into making an SIP or Systematic Investment Plan.

First and foremost thing is amount Radhika will invest. Also called as SIP amount. Here Rs 5000/- is her SIP amount. Most Mutual Funds allow you to start as low as Rs 500/- per month. Generally there is no upper limit.

Frequency is next thing. In this example, frequency is monthly because Radhika is investing every month. You can invest daily, weekly, monthly, quarterly, semi annually or yearly. They are called daily SIP, weekly SIP etc. Monthly SIP is most common and popular.

Third thing is Duration of SIP. This tells how long you will be doing this periodic investment. In our example duration of SIP is 5 years or 60 months. Radhika will be investing this amount for 60 times. Generally you would decide duration of SIP based on goal you want to achieve. If goal is retirement planning, SIP duration could be for 20 or 25 years also. Generally Mutual Funds need minimum six months to start an SIP.

Next is Date of SIP. In this example 7th is date of SIP. Money from Radhika’s bank account would get invested in mutual fund on this date. Most mutual funds allow you to chose the date. Generally people select some date just after salary date. So if you get salary every 10th of month, you could decide SIP date as every 13th of 15th of month.

Last and probably most important thing is deciding Mutual Fund Scheme to invest. Radhika decided to go for ICICI Prudential Bluechip Fund. Based on your goal, risk profile and advisor, you will need to decide which mutual fund to invest in.

So now you have all the ingredients, let us make a tasty drink.

Recipe

Making of a SIP -  - Systematic Investment Plan

There are two ways to start an SIP. You can go offline way by filling up an SIP form. Or you can do it online. Either way SIP would work in same manner. So chose what you are comfortable with. Online SIP adds convenience as you can stop, edit, cancel without visiting mutual fund AMC office or your agent. But you can take a call based on your comfort of dealing online. There is no difference in returns whichever way you go.

Why SIP

By now I think it is clear SIP is not a product to invest in. We are investing in mutual fund itself. SIP is just a process of how we can invest. So now you have two options. Even if you have large money to invest, you can decide how to invest it. You can invest entire amount in one go. That is commonly called as investing lumpsum. Or you can decide to put small amount over a period of time. This is SIP. Or you could also mix both approaches. Invest some amount say 50% as lumpsum and remaining amount as SIP. Underlying thing in both of these is Mutual Fund. Only difference is are you putting your money in that Mutual Fund Scheme in one go or you want to do small amount say every month.

Reasons to go for SIP

1. Spread the investment

First and foremost reason is retail or common investors are afraid to invest in stock market. Equity Mutual Fund is just another way of investing in stock market. So there is always apprehension that what happens if I invest say Rs. 5 Lac in an equity fund and market goes down in a month by 30 %. We have seen this in last month due to Cororna crisis. Your fund valuation will also likely to go down suddenly. Not many people are comfortable to be in this situation. SIP gives them option to spread money across large time period. If you are investing small amount over a large period of time, you are spreading the investment over a large time period. People found it more comfortable to invest Rs 5000/- over next 100 months rather than Rs 5 Lac in one fine day.

2. Convenience

SIP -  - Systematic Investment Plan can be managed online

Once you register an SIP, there is little one needs to do till SIP ends. Money would get directly debited from your account on specific day without any action from you. When SIP duration nears the end, investor generally gets reminder from fund house of app they are using to extend SIP. So you have choice to continue or stop it. Now funds are offering online mechanisms to stop, pause, modify SIP at a click of button. So using any descent app, you can easily manage SIP sitting at home. In nutshell, you have full freedom to stop or change SIP at any stage.

Currently I use Kuvera App for myself. I found it to be a good app for doing investment in direct plans of mutual fund free of cost. You can read my review of Kuvera here.

3. Cost Averaging

As investor invests money over long period in SIP, one generally buys mutual fund at different cost or NAVs (Net Asset Value). So when market is down and NAV is low, investor gets more units. This helps accumulate more units even when actually we are going through adverse market situation. Overall your cost gets averaged out during the SIP period. Just to explain with an example. If you invest 5000 for six months and NAV each month is say 20, 22, 24, 22, 20. When NAV was 20, you would get 5000 divided by 20 which means 250 units. When NAV was 22, you would get 5000 divided by 22, which is say 227.27 units. SO on so forth. As NAV increases, you get less units and as NAV drops, you get more. Thus you will get average price across your entire SIP period.

4. Suits salaried class

Salaried class gets their income or salary every month. So investing small amount just after salary is credited is more suitable for them rather than investing large amount in one go. People are able to quickly co relate SIP to recurring deposits of bank or contribution to providing fund every month. Investing some amount from salary was not big deal compared to lumpsum investment. Most fund house keep minimum SIP amount as low as Rs 500/- per month. So its easy to implement.

5. SIP concept is easier to put down the throat

It is like this. A glass of some new drink. If someone tells you that you need to drink it at once, you may have some apprehension. But if same drink is offered with another option. Drink sip by sip. If you don’t like, you can leave it any time. Most of us would take the second offer. Mutual Fund was a very new drink for Indian Retail investors. All their parents advising them against investing in stock market. So SIP proved a good thing to try it out with less perceived risk.

Imagine a distributor coming your home and trying to convince you to invest Rs 5 Lac now and explaining you that it will become Rs 50 Lac in say 20 years. In other scenario, consider he or she suggesting to invest regularly just Rs 5000/- per month and see how it goes. You can stop any time. You can imagine second approach is much easier to sell.

6. Power of Compounding

SIP helps you to take benefit of power of compounding with a very small amount. You need not start with large investment. With small contribution in a appropriate mutual fund, you can accumulate a very large amount over long period.

If you start an SIP at young age, you can have unbelievable corpus at the time of retirement. You can have a look at SIP calculator here. Try a small amount like Rs 5000/- per month for say 30 years with return between 10 to 12 %. You will be surprised with what you can get at the time of retirement. That too with such small contribution per month. Number of years is key here. Larger the time you give your money to grow, more amazing is result.

Just for sake of trying, think of starting SIP of say just Rs 1000/- for your child when he or she is born. Ask them to continue it once they start earning till their retirement. So SIP of Rs 1000/- for 60 years. May be first 20 years you contribute and next 40 years child himself or herself contribute. Use above SIP calculator and see what Rs 1000/- SIP becomes in 60 years.

Retirement Planning with SIP - Systematic Investment Plan

Now time to see other side of story.

Reasons SIP is not so great

1. SIP returns are different than what are published Annual Returns of Mutual Funds

Yeah. You read it right. In any mutual fund advertisement, you see 1, 3, 5 years and “since inception” returns. These returns are based on investment done in lumpsum in that fund these years back and not SIP returns. So if you use these returns to calculate your maturity amount but invest via SIP, it will not give you true picture.

This is because when you do lumpsum investment, your amount is invested for entire period. Let us say you have 3 Lac and you invest lumpsum for 5 years. Here this money is in fund for entire 60 months. Instead, let us say you decide to do SIP of 5000/- for 60 months. Now amount of investment is still 3 Lac. But what happens in case of SIP is little different. Your first SIP is invested for 60 months. Next gets 59 months. So and so forth. Last SIP is invested in last month and is available for only for 1 month. So though returns published by fund house are correct, your money will not earn those returns for entire 60 month. So if you look at average return, it will be different than what you could have earned in case of lumpsum investment.

You can have a look at Moneycontrol website for any fund. Let’s say same one selected by Radhika. ICICI Pridential Bluechip Fund. You can click here. You will see annualized and SIP returns as different. It is ultimately based on how much period of your SIP, market was high or low which will decide SIP returns to be more or less than annualized returns.

2 Timing does play a role

Timing  does play a role

As we know Equity investments are keep going up and down in value. You will never get uniform return every year. Purpose of SIP is not to time the market. One should just keep investing even if its up or down. That is what we are told. My personal opinion is not same though. I feel timing especially period nearing your goal is crutial. Let us try to understand with an example.

Let us assume you do and SIP for 20 years. This period is fairly long for equity market to help you manage ups and down. At least that is what we are told. For simplicity let us assume, out of 20 years, you get consistent returns for 19 years and there is only 1 bad year.

We want to simulate overall average 11% return. So lets take example where you get return of 14% for 19 years and there is just 1 year with negative 45%. Now look at below four scenarios. You will see that all of them will give different maturity value at end of 20 years. Only difference in all four cases is WHEN this bad year comes. If bad year comes early in your investment period, you will get more than your expected calculation. Whereas you can see how bad impact is when it comes late. As it starts coming later and later, your maturity amount gets reduced by large amount.

  • With uniform return, you should get more than 71 Lac
  • Second year of investment is bad for market – You gets 90 Lac
  • Eighth year of investment is bad for market – You get 66 Lac
  • Fourteenth year of investment is bad for market – You get 55 Lac
  • Last (20) year of investment is bad for market – You get just 50 Lac
Valuation of SIP when we have one bad year at different stage

Even if you keep first scenario out of equation. Next four scenarios are exactly same where 19 years were with exact same 14% return and one year returned negative 45%. Still your maturity values are very different to the extent from 90 Lac vs 50 Lac. That is difference of almost 80%. Out of four times, only one time you could get better than planned goal. But in other three cases, you may get less than what is planned for.

So SIP does not save you from bad market condition all the time and there is no guarantee that you will achieve your goal even if average returns are as expected. This is because nature of SIP. In early period of SIP, your overall amount invested is less so even if there are down turn in valuation, you don’t loose a lot. Say SIP of 5000/-. After a year, your investment is 12 months multiplied by Rs 5000/-. So Rs 60,000/-. Lets assume it has become may be 66,000/- due to returns in stock. Now there is a down turn and even if fund goes down by 50%, your value goes down to Rs 33,000/-. So your notional loss is Rs 33,000/-.

Now let’s take other end of scenario. Where you diligently continuing SIP and after long time, your value is Rs 66 Lac. You are nearing your goal and market crashes. Again let us take same scenario than fund goes down by 50%. Now your valuation is again going down by 50% only but amount is now Rs 33 Lac. We will see in some other article how to avoid getting into such situation but point I am trying to explain is just by doing SIP, don’t assume risk is gone.

Even reverse is true. If you see below figure, you can see one good year will differentiate maturity value based on when it happens. Late it happens in your SIP period, more the benefit. Overall later part of SIP has more influence on your overall maturity value even in SIP.

One good year in late stage of SIP can make lot of difference

3. SIP is not always better than Lumpsum

We know Systematic Investment Plan spreads risk over longer period. It helps in reducing ups and downs in stock market. However if your goal is really long term. Let us say you want to invest for child higher education may be 15 years down the line. If you do not have money to invest in lumpsum then you have no option but to go for SIP. But if you have some money say 3.6 Lac in hand then what you do. If you invest it in lumpsum now, then you are giving full amount a chance to grow in next 15 years. Even if market crashes immediately after your investment is done, still it is likely to recover and provide good returns in period of 15 years.

If however you take a very safe approach and do SIP. Then you will invest 3.6Lac divided by 180 months = 2000/- per month for 15 years. My personal view is that there is problem in this approach. Very small amount is getting invested for initial period. Your first SIP of 2000 will be getting chance to grow for 15 years but subsequent each SIP will start getting one month less. So you are not taking full benefit of money that you have.

If you are afraid to put money in equity in one go, you can go SIP route but don’t try to spread it across entire 15 years. You can invest 3.6 L / 36 months or 3 years = 10,000/- per month. This will make sure you invest entire amount in 3 years. So entire money would get time to grow for at least 12 years if not 15.

You may ask, what if market crashes after 3 years. That risk you always carry even if you do SIP for 15 years. What happens if market crashes just a month before you were going to withdraw your money. But in our case, you still have 12 years for market to bounce back and give some descent returns.

4. SIP in Debt Funds doesn’t make sense

We don’t drink water sip by sip. So all the drinks are not to be taken same way. Same is for Mutual Funds. Not all funds suit SIP or Systematic style of investment. Debt funds are like water here. It makes more sense to gulp it in one go. Let us see why?

No Systematic Investment Plan  for Debt Mutual Funds

Debt funds invest in financial instruments which are more like loan given to someone – bank or corporate or government. NAV of these funds do not fluctuate as much as Equity mutual funds. So doing SIP in them is not of much use. Again just my opinion. You have right to disagree.

Also debt funds have different taxation in India compared to equity funds. For debt funds, you need to hold them more than 3 years to get benefit of indexation for Long Term Capital Gains ( LTCG ). If you sell it within 3 years, you will need to pay short term capital gain (STCG). STCG is taxed as per your income tax bracket. If you do SIP in debt fund, then you need to wait for three years after your last SIP month to qualify entire amount for LTCG. So it lengthens withdrawal period. If you invest in one go or lumpsum, then entire amount you can redeem after 3 years with taxation benefit. It is more convenient as well.

If you do not have lumpsum to invest, you can very well do SIP in debt fund. Point here is if lumpsum is available, it makes more sense to invest it full. Think of it like this. You have money at your hand. Will you go and do Fixed Deposit for full amount or open a recurring deposit and invest small amount every month. Since in FD amount is fully invested for entire period, you will get higher maturity value than RD. If your answer is FD, then lumpsum is strategy for debt fund. If for some reason, your answer is RD then go for SIP.

5. You still need to monitor SIP and performance

Monitor SIP - Fund Performance

SIP or Systematic Investment Plan is not like Hero Honda advertisement. Fill it, Shut it and Forget it. No. That’s not the case. SIP is just a manner of investing in mutual fund. So selecting correct mutual fund as per your goal, duration and risk profile is very important. Once SIP is started, you need to monitor scheme you selected is performing on par with it’s peers. SIP in wrong mutual fund will not save you from losses. Because ultimately you are investing in a mutual fund. SIP is just a convenient way to buy it. You need to stop SIP in under performing fund and move to better fund. Of course you should give sufficient time to any fund before taking a decision. Also some time fund manager changes, there could be strategy change, your scheme may get merged into another scheme etc. So you need to take appropriate measures.

Also goals do change over period of time. Your risk profile could also change as your grow old or there is insecurity in job. Your income could increase / decrease. You need to keep monitoring and adjusting SIP as per situation.

6. SIP makes portfolio re balancing difficult

Re Balancing Portfolio in Systematic Investment Plan

If you ever worked with fee based advisor, you would know they charge yearly fee. First time to setup your portfolio and then subsequently to monitor , review and re balance. Generally one should review portfolio at least once in a year. Let us say during your yearly review, you realized particular scheme is not doing well. You now want to stop this SIP and start with new scheme. You can easily stop first SIP and start new.

But how do you switch whatever invested so far in first scheme to new scheme. Tax benefit is available for equity mutual funds only after one year of completion. If you redeem all units now, then all SIPs done in last one year will not be eligible for tax benefit. Also many equity schemes charge exit load if you redeem in a year. This causes some inertia to redeem money at right time. You stay with not so good scheme for one more year. This is so that all the SIPs invested in last year also get qualified for tax benefit and we don’t incur exit load. If you have invested in lumpsum, you can easily redeem and switch to new scheme after a year.

Other things you should know

  • You can have more than one SIP going at a time. Each SIP is independent of each other. So you can chose different amount, frequency, duration, date and schemes. They do not impact each other in any way
  • If on the day of SIP, your account does not have sufficient balance, SIP of that month will get reversed. Naturally no mutual fund units that month. So far fund house don’t charge any penalty if that happens. Bank may charge some penalty if standing instruction bounces due to insufficient balance. Check out charges with your bank. Generally if three SIPs are reversed in sequence, SIP gets cancelled by fund house.
  • In SIP, amount gets deducted automatically from you bank account. So you will need to give a bank mandate to honor the SIP. If you are doing offline SIP, you may need mandate with every SIP. In case of online mode, one time mandate is generally sufficient.
  • No impact on Tax – Please note SIP or Systematic Investment Plan is just a different way of investing your money. You are choosing to invest small amount multiple times rather than one big amount in single go. Decision of Tax break or other wise is based on underlying mutual fund. Whatever tax benefit is available or not available to selected fund will be treated in same manner – SIP or Lumpsum investment. So if you invest in ELSS (Equity Linked Saving Scheme) which has income tax deduction, you will get that benefit in both approaches. Lumpsum or SIP.
  • No impact on Lock-in – Again same point. SIP is just a process of investing amount. So if underlying mutual fund has some lock-in, it will be applicable to SIP and Lumpsum investment in same way. Just one additional thing on lock-in. Let us say you invest in ELSS via SIP. ELSS Mutual Funds has 3 year or 36 months lock-in period. That means you can not redeem units for 36 months. When you do SIP, money invested in first month can be withdrawn on 37th month. Money invested in second month will be available in 38th month. So and so forth. Lock-in period of each investment is from date of that particular SIP.

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