How SIPs Can Make A Big Difference To Your Investments

The Systematic Investment Plan looks like such a boring concept. You just take a fixed sum of money each month and keep pumping it into the same fund month after month and year after year. What exactly is so special and unique about SIP? The point is that it is really effective when it comes to creating wealth in the long run. The graphic below explains why SIPs create wealth more effectively.

What if you had invested in 2007 and reviewed your investment in 2017?

The Nifty and the Sensex were at their peak in 2007. Obviously, a first time investor would not know what the top of the market is and what a market bottom is. Assume that Rajiv had invested his bonus of Rs.10 lakh in 2007 into an index fund. He found passive investing quite appealing. You do not have to worry about individual stock selection and the Nifty and Sensex had anyways done very well in the long run. So, why should he worry? When he reviewed his portfolio in September 2017 after almost 10 years, he realized that the NAV of the fund had just moved from Rs.10 in 2007 to Rs.16.50 in 2017. A total return of 65% over 10 years translated into annualized CAGR returns of just 4.8% per annum. That is slightly more than what Rajesh would have earned in a bank savings account and sharply lower than what he would have earned in a liquid fund. Where exactly did Rajesh go wrong? After all 10 years is as long as long-term can be.

What if Rajesh had done a SIP instead?

Now let us assume that Rajesh had adopted a slightly different strategy! Had Rajesh invested the entire Rs.10 lakh in a liquid fund and slowly invested Rs. 10,000 each month into an index fund as a SIP; what would have been the outcome? The SIP on the same index fund over the next 10 years would have yielded an annualized CAGR of 12.3%. Additionally, the liquid fund would have yielded an additional 2.5% per year on the idle money making it an annualized CAGR of 14.8%. Effectively, had he opted for an SIP instead of a lump-sum investment, he would have earned 10% higher returns annually. Why has the SIP made such a big difference?

What Rajesh would have got from the SIP but did not from the lump-sum investment?

The 10% annual difference in returns between the SIP and the lump-sum investment is because of the 4 key benefits of a SIP that Rajesh missed out.

• When you adopt the SIP route, the volatility works in your favour. The period between 2007 and 2017 was an extremely volatile period. When the index went up, the value of the SIP would have gone up and when the index went down, Rajesh would have got more units of the fund allotted. That is called rupee cost averaging (RCA) and it works in favour of an SIP.
   

• Rajesh was never in a position to identify market tops and market bottoms. In fact, even the best of traders fail to consistently identify market levels. When he invested a lump-sum in the index fund, his assumption was that he had got the timing right. Had he done a SIP, he would not have to worry about timing at all. The SIP will negate any timing influences.
   

• The SIP in the case of Rajesh would have made much more efficient use of his money. Let us understand this better. When he invested the entire money in an index fund, the money was just idling and not yielding anything. Had he put the money in a liquid fund, the idle money will continue to earn at least 6%. In the case of the SIP, the actual return gets a boost due to the return on the liquid fund.
   

• The SIP moves the investor from the rigidity of point-to-point returns to the flexibility of a series of annual returns. When you do invest lump-sum your returns are with reference to your investment date. If you were unlucky enough to get in at the peak, like Rajesh, then your investment will underperform. The SIP, instead, used the volatility in each of the 10 years positively.

Perhaps, the most important argument in favour of a systematic investment plan (SIP) is that it is realistic. Getting regular income flows is more realistic than getting lump-sum amounts. A SIP ensures that your investment outflows are synchronized with your income flows. But, above all, SIP is all about discipline and regularity which is the key to long term wealth creation. That is why, the SIP, best fits into your long-term goal planning!

AUM as on: May 2018; Returns as on June 14, 2018; Source: ACE MF

Returns less than 1 year are absolute and more than 1 year are CAGR

Mutual Funds are subjected to market risk