Earning or Spending monthly? Then Save monthly. Understanding SIP

During one of my recent meeting with a prospective client for  financial planning, we started a discussion on mutual funds and his first reaction to it was- “I would not want , even my enemy to invest in mutual funds”. I surely knew he would have got a very bitter taste of investing in mutual funds.  While taking the discussion further, I found that all his investments in mutual funds were done as  lump sum investments in equity funds during Dec. 2007 to Feb 2008, the time when Sensex and Nifty were at all time high. Moreover the gentleman who had suggested him these funds had also more or less assured that the funds would double in 3 years. It was the worst of the investors’ nightmare when  the fund value reduced to almost 50% in one year’s time and he barely managed to get his capital back by end of September 2012.

There would be hundreds and thousands of such cases today, where people who have invested or  were made to invest   at one time in equity funds, are not happy with the returns that  these investments  have given. A tenure of 4-5 years is a fairly good tenure to show some kind of returns on your investments. At least  in India,  we have never looked upon mutual funds from a period beyond 2 or 3 years and the expectation rises to double digit return during this tenure of investment, irrespective of the market conditions. So what really went wrong while doing investments in these Mutual funds? Were the schemes selected wrong or the fund houses were not good? In fact, both the schemes and fund houses were top performing in the market.  The only mistake the investor and his mutual fund distributor (I am not using the word Financial Advisor for him) did was to invest in Equity schemes at one time and that too when the markets were at all time high.

You have to play the game by its rule to enjoy it. One cannot apply cricketing rules to Football and say the game is no fun. While you invest in Equity mutual fund, apply the rule of Systematic Investment Plan (SIP). There are more than one benefits of doing  SIP. Following are those :

1)   Rupee cost Averaging: Any market works on volatility,  be it Equity, commodity or these days even Debt market has lot of volatility. SIP is the best route to beat this volatility.  By investing at regular intervals you get down your average cost of purchase, as markets would keep fluctuating, you would have actually made purchases at regular intervals. Let’s take an example, say you invest funds one time today when the Sensex is about 18600 level and in next one year the Sensex goes down to 16500 and comes back to the same level of 18600 ( not that I am suggesting the markets would go to these levels, this is for illustrative purpose) your fund value would either be same or may be less than invested. But through SIP route your investment is happening right up to 16500 level downward and again upward to 18600, hence by doing this, you reduce your purchase cost and you would be in profit when the Sensex is back to 18600. 

2)   Discipline while investing : When you commit to set aside a particular amount every month you are getting more disciplined as an investor. A simple logic that I ask  my clients  to follow is, we earn monthly, we spend monthly so we also have to save monthly. Hence you become more disciplined financially, since you would know you will have to make arrangement for a particular amount on a particular date towards your investments.

3)   You don’t have to time the market : A common mistake that most of the investors do is to time the market., They would want someone to exactly tell them, that this is the low point in market, you buy now and this is high point in market, you sell now, which is humanly impossible. SIP helps you to stay at all levels and hence to a greater degree allows you to time the market, in-fact in equities TIME IN market is more important that TIMING the market.

4)   Power of Compounding :  Albert Einstein referred to Power of Compounding as 9^th wonder of the world. SIP for a longer tenure helps you grow your investment because of power of compounding. Instead of investing a lump sum it is better to invest regularly. Have a look at following table :

Suppose someone sets aside Rs 5000 per month at different age till his age 60 what would be the amount accumulated at age 60.

Investment returns @ 10% 

AGE	Invested Amount	Value at age 60
30	(5000 X 360 months) =  1800000	1,13,02,439
35	(5000 X 300 months) =  1500000	66,34,167
40	(5000 X 240 months) =  1200000	37,96,844
45	(5000 X 180 months) =    900000	20,72,351

It's often said that you may become rich by earning lot of money, but you can become wealthy only by properly managing the money you earned. Few things one should bear in mind while taking the SIP route are :

Ø  SIP is a mode of investment and not a mutual fund scheme.

Ø  Past performance of any SIP should not be the parameter to choose the fund.

Ø  SIP returns are never guaranteed, not even the Capital. Hence if you are looking for a guaranteed returns product, do not select equity mutual fund.

Ø  SIP does not assure better returns than lump sum investment, but helps you to average your purchase cost if your investment horizon if of long term.

Ø  Start taking SIP route for your medium term or long term financial goals.

Ø  Select a financial goal and start your monthly investments towards that goal.

A convenient way of investing on monthly basis and reaching your targeted financial goal, thus helping you to follow a simple rule of investing which is ‘When we Earn monthly, spend monthly, why not save monthly’

Happy Earning and Happy Investing  !!!