SIPs cut market-timing and investors must choose a tenure that covers both up and down markets
A Systematic Investment Plan (SIP) is one of the most preferred routes for investing in equity funds by most investors. It has gained popularity due to its commonly known benefits. These are a low minimum investment, inculcating investment discipline, rupee cost averaging, the benefit of compounding power, and no requirement to time the market, among others. March 2021 saw the SIP collection at Rs 9,182 crores which was 6.3 per cent higher than the previous corresponding period. It signifies more and more investors are turning to SIPs as a mode of investment. The longer one invests, the more beneficial it is for the investor. However, investors need to keep in mind a few additional points while investing through SIPs:
Average Holding Period
When an investor invests for 20 years, the average holding period for each SIP is just ten years. This is because, at the end of 20 years, only the first SIP instalment has completed 20 years. In contrast, the last SIP instalment may not have even completed one month. Hence, even though the investor may have been investing for 20 years, the average holding period is just ten years. Thus, investors should consider the average holding period and not the start date of their investment to determine the holding tenure.
Power of Compounding
One of the advantages of investing through an SIP is the benefit of the power of compounding. To understand why investing for a longer-term is more rewarding, let us consider an SIP investment of Rs 10,000 per month for different periods.
As we can see from the above table, the amount of additional investment is Rs 3.6 lakhs every 3 years. Yet, for the same amount of additional investment, the incremental value increases at a much faster rate as the period increases. For example, after 15 years, the incremental value has increased by 3.86 times over the additional investment (Rs. 13.9 lakhs/Rs. 3.6 lakhs). In contrast, it is only 1.58 times in 6 years. This factor is often neglected as a human mind attuned to arithmetic progression and not geometric progression.
Even as investors continue to invest through SIPs, many stop SIPs prematurely, while others withdraw the funds before the tenure is complete. It is generally seen that investors commit to continue SIPs for long durations of 7-10 years but end up discontinuing the SIPs mid-way after 3-4 years. There can be many reasons due to which investors do not continue with SIPs. Some of them are as discussed below:
- 1. Market Volatility
Generally, most investors are told to expect returns over 10-15 years to be around 12-15 per cent per annum. However, these returns are not linear. We cannot assume that we will receive positive returns year after year, as we can in a fixed deposit. SIPs in equity funds are affected by market movements. Thus, the gains of the investors move up and down with the direction of the market.
Returns from equity funds will never be in a straight line. Let’s consider calendar year NIFTY 50 returns for the last 20 years. The maximum return that an investor earned in any calendar year is 78 per cent (2009), and the maximum loss is -51.8 per cent (2008). Thus, the returns would constantly get averaged out and could be high or low depending on market movements. To compare these returns with fixed income would be one of the biggest mistakes made by any investor.
- 2. Transparency and Ease of Redemption
Mutual funds are transparent in dealing with investor’s money. The NAV of funds is available daily, and the portfolio of funds is available monthly. This is beneficial as investors get to know where exactly their money is being invested. On the other hand, this also acts as a drawback as any negative news about a specific company creates nervousness among the investors and often leads to panic selling by investors. Other investment vehicles, like NPS and ULIPS from Insurance companies, may also invest in these securities. Still, the details of the same are not publicly available. In the case of mutual funds, ease of redemption is another factor that acts as a drawback. Since investors can quickly redeem their investments, investors look to redeem them even if there is a slight deviation in returns from their expectations.
- 3. Dissatisfaction with Returns
Another reason why many investors decide to discontinue their SIPs is dissatisfaction with the returns of the fund. Investors start SIP, and within a short period of 1-2 years, they begin evaluating the returns they have earned. At this point, investors feel they have made a wrong investment decision, not realising that for a two-year SIP, the average holding period is only 1 year. They start comparing with other stocks or even the NIFTY and Sensex. This is a whole apple and oranges comparison. Still, since their direct experience is not good, they do not listen. Some investors shy away from mutual funds, thinking these won’t provide good returns on their investment. Others take hasty decisions and exit from their investments. If investors exit from their investments in the short term, they miss out on the gains they can earn later.
Our internal research of equity funds (growth option) considering inception 20 years ago (before July-1999) shows the following with an average value of all funds with SIP of Rs. 10,000 per month in as the table below:
The above table indicates that investors money invested with a 20 years horizon has increased more than 12.2 times for the best to 3.3 times for the worst.
Volatility & Probability of Negative Returns
It is generally observed that a longer tenure reduces the probability of negative returns on SIPs as volatility in returns is reduced. To understand this better, the example of Kotak Flexicap Fund, a fund with the largest assets under management among all open-ended equity funds (except for index funds) as of February 2021 and has been in existence for more than 10 years.
From the above table, it is apparent that negative returns are high for a one-year investment tenure. In contrast, the same reduces as the tenure increases to 2 years. There are no negative returns if the investment tenure is three years or more, except for 2017-18. In that year, three-year SIP return was affected by the Covid-19 pandemic. A marked improvement in return is noticed once the tenure of a SIP crosses five years.
The Secret to Successful SIP Investing
Understanding that SIPs are meant to eliminate market-timing, investors must opt for a SIP tenure that is long enough to include both up and down markets. For example, Warren Buffett first started investing at the age of 11. Still, he became a billionaire only when he reached the age of 56.
The author is Director, Ventura Securities.
DISCLAIMER: Views expressed are the author’s own, and Outlook Money does not necessarily subscribe to them. Outlook Money shall not be responsible for any damage caused to any person/organisation directly or indirectly.