Think before you invest in a SIP
SIPs may not be the best bet when investing in a market making upward trends. We compare lump sum investments against the SIP to give you a better idea of the concept.
In the last few trading sessions, the markets have been touching new highs and it is safe to say that we are in a rising market. People normally start thinking of investing in equities when markets start moving up. The Systematic Investment Plan (SIP) is often regarded as the best way – and quite often the only way – to invest in equity-linked mutual funds. Perform an internet search of the term and you will be bombarded with information glorifying its benefits.
However, in a rising market, investing in an equity-linked SIP scheme is probably the worst idea.
As investments are done on a periodic basis, SIPs average the cost of investment and thus protect you from market volatility, both on the upside as well as downside. Though the amount you invest is fixed, the number of units you purchase varies on the state of the market. You get more units when the market trends downwards, and fewer units when the market moves up.
Lump sum investing does not benefit from cost averaging. An ideal scenario would be one where you invest a huge sum at the start of an upward trend and stay put. But that means you would have to time the market, which can go horribly wrong and such a move is generally ill advised.
Here’s a simple example to help understand this better. Let’s look at a comparison between a lump sum investment of Rs1,20,000 and a monthly SIP of Rs10,000 over a period of 12 months.
Assuming the cost of each unit is Rs100, you get 1,200 units of a fund for Rs1,20,000. If prices consistently move up during the year and touch Rs210 per unit, your investment would make a clean 110% profit and would be valued at Rs2,52,000.
However, during the same period if you had taken the SIP route, you would have made much less. Under the SIP format, an investment amount of Rs1,20,000 would be split into 12 equal monthly instalments of Rs10,000 each. This way only your first instalment would be at Rs100, fetching you 100 units. All subsequent instalments would be made at higher prices, reducing overall returns.
|Month||SIP Amount (Rs)|| Cost per Unit
At the end of 12 months you would have approximately 816 units and your investment will be valued at Rs1,71,442.
This is not to say that SIPs are a bad bet. Investing systematically does have its limitations but it is still the best way to invest in an equity-linked mutual fund. In fact, in a declining market, SIPs are among the best investment options. A SIP also enforces a habit of saving, especially if you don’t have the money for a lump sum investment. However, you must remember that for any SIP to be effective you need to stay invested for a long period of time. Opting out from an SIP mid-way does more harm than good.
So it makes sense for you to check which way the winds in the market are blowing instead of blindly going in for an SIP, just because it is marketed as a silver bullet.