Mutual Fund SIP – plan or plunder

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SIP or Systematic Investment Plan has long been touted as a silver bullet for retail investors, especially for those who want to start investing in equities. This investment vehicle is promoted by all the mutual fund houses, distributors and financial planners. It has been marketed as the safest mechanism of equity investment that will outperform the markets and creates wealth over a long term. It is really hard (even for Google) to find articles that talk about problems or disadvantages of SIP.

Almost all the marketing around SIP indicates the following advantages:

Rupee Cost Averaging: The basic idea to make money is to buy at lower level. SIP allows you to buy more units when markets are less, thus reducing your average cost of buying units. But it is never mentioned that this method will work only in specific market conditions where the markets are in median range, then markets goes downwards and ultimately moves up. The intermediate downturns will cause SIP to buy more units and when the markets finally moves up, it gives better returns due to lower average cost of buying. The other market conditions are not favourable for SIP investment and some conditions are even detrimental as well.

Disciplined Investing: The basic idea is that a investor is 'forced' to invest regularly since the SIP amount is automatically debited from the saving account. But I believe that disciplined investment is really a habit rather than an advantage of any investment vehicle. It just forces an automatic deduction of SIP amount from your bank account, which is also true of other simple investments like recurring deposits.

The only one who gets benefit out of MF SIP is the mutual fund house and their distributors, since they get a regular committed revenue stream without spending any time or effort. SIP is just an investment vehicle to put your money into the underlying assets (which could be equities, bonds or gold etc.). So common sense tells us that if the underlying asset is doing badly, there is no way SIP is going to make money. The last 5 years (2007-2012) has not been particularly good for equities and hence it is no surprise that investments made into this asset class (be it via SIP or lump sum) are not doing very well.

It is a myth that SIP can give positive returns during any market condition. SIP will only perform when the timing (start/stop of SIP) and duration is right, as it is true with the underlying asset. A quick chart of SIP Vs. Lump sum investment might provide some insight:

Market State

Systematic Investment Plan

Lump Sum Investment

 

Rising Markets

As the market rises, your average cost will keep on increasing.

Your investment made is at the lowest price and hence the gain is superior

Lump Sum Wins

Falling Markets

As the market is going down, even if your average cost of purchase is reducing, but so is your final NAV and you are losing money

Your investment is at the highest price and hence the you will suffer losses

You lose in both cases

Markets with intermediate

downtrends but ultimately rising

The intermediate downtrends will cause SIP to buy more units and hence reduce average cost of buying. The ultimate NAV will be higher giving handsome gain.

The investment will not use the intermediate downtrends, so any gains will be marginal

SIP Wins

Markets with intermediate

uptrends but ultimately falling

The intermediate uptrends will cause SIP to buy less units and hence increase average cost of buying. The ultimate NAV may be higher but gains are less due to rising average cost.

The investment will not be impacted by intermediate uptrends

Lump Sum wins by a slight margin since it did not get affected by higher cost during uptrends

So the returns of a SIP will definitely depend on the

· Timing - Start and Stop of the SIP

· Duration – The duration for which the SIP was operational

As far as the disciplined investment goes, it is useful to note that there are other investment vehicles which can be combined with lump sum equity investments to ensure some discipline. As an example, instead of a SIP, an investor can choose to open a recurring deposit for six months and invest the lump sum received directly into mutual fund at the end of six months. It is also beneficial in terms of cost overheads, here is the comparison:

Case 1:

Case2:

Comments

SIP investment in Mutual Fund of Rs 2000 for six months

Recurring Deposit of Rs 2000 for six months + lump sum investment in same MF after six months

 

(Rs 30 + Rs 3.71) X 12 = 74.52 Rs commission to mutual fund house (ICICI Direct charges)

(Rs 33.71 - Interest earned on RD @ 6.5% pre-tax)

(ICICI Bank Interest**)

So the cost of Mutual Fund SIP is higher due to recurring nature of commission. Also which of the option will give higher returns will depend on timing of the investment.

**Another point to keep in mind is the pre-mature withdrawal penalty on RD (0.5% in ICICI) compared to exit load (1-3% before one year).

So SIP is not a magic wand which can give you positive returns irrespective of market conditions. It is rather a “Systematic Investor Plunder” and benefits the MFs and distributors most of the time. The only sip that will give you pleasure is sipping your tea!