With over Rs 7,000 crore coming in each month, the SIP has become a byword for investing. But popular as it may be, the concept of it – what is an SIP, what it does, why it is useful – is still lost. This is especially true after the market rout of last year where SIP returns seemingly dipped. So here’s what an SIP is and what it is not.
SIPs are a method of investing.
We’re starting simple. An SIP is an investment made at periodic investments in a set of mutual funds (or stocks, since you have stock SIPs, but that’s a discussion for another day). While the frequency is up to you, monthly periodicity is the most convenient.
A fixed sum is invested each month, but you can change this amount at any time. An SIP is not a product on its own. It is just a way to invest in mutual funds. You don’t have SIPs and a mutual fund investment. You only have a SIP investment in a mutual fund.
SIP returns depend on the market.
Since SIPs aren’t an independent product, they don’t have their own returns. The performance of your SIP depends on the performance of the fund in which you are running the SIP. Your fund’s performance in turn depends both on its own strategy and what the market is doing. By market, we mean both the debt and the equity market.
SIPs do not guarantee returns nor ensure positive returns.
Since SIP returns depend on the market, it cannot guarantee a certain level of returns. Let’s say you have an SIP in an equity fund. Stock markets correct. The fund would also see returns dropping as stock prices drop. How can your SIP then generate high returns?
For example, let’s say you started an SIP in ICICI Prudential Bluechip in January 2016. The SIP returns would today be 9.1% IRR. At the start of 2018, the same SIP returns would have been 23.4% IRR. That’s because markets were sliding over 2018. Remember, SIP is just investing in a fund at multiple points. It cannot guarantee returns.
In the same way, just because you have invested through an SIP, it does not mean that your returns will always be positive. Again, if markets go through a prolonged phase of correction as it has in 2018, it is possible that your SIPs are in losses. For example, if you started an SIP in HDFC Midcap Opportunities in January 2017, it would today be -1.24% (IRR). The benchmark Nifty Midcap 100 is down 15% over 2018. How is it possible for a SIP to stay positive when the fund and its underlying stocks are in losses?
SIP returns slipping into the negative is especially possible if you started a SIP at a high point, like 2017. Continuing the HDFC Midcap example, if you had started the SIP in January 2016, the IRR would have been much better at 6.2% IRR.
An SIP involves buying at different prices.
Why does starting an SIP at a higher market point result in lower returns when markets correct? Bear in mind that SIP returns are primarily influenced by fund and market performance. SIPs involve buying at different prices, which is a second factor influencing returns. When you have an SIP and markets are rallying, you are buying at higher and higher prices. In effect, you are averaging your costs up.
Continue with HDFC Midcap Opportunities. If you started your SIP in January 2017, your average cost per unit would have gradually climbed from Rs 43 to Rs 52 by January 2018. If you started the SIP in January 2016, the average cost would have risen from Rs 37 to Rs 44. When the correction hit in 2018, it would have a bigger impact on your returns in the 2017 SIP than the 2016 SIP.
Now, what happened in 2018? An SIP started in January 2018 would have averaged costs down from Rs 61 to Rs 55 by January 2019.
An SIP needs to run for a longer time.
If starting at a high means lower returns when markets correct, does it mean an SIP needs to be timed like a lump-sum investment? Wasn’t removing the need to time a benefit of an SIP? No. SIPs do remove the need to time lows and highs.
The key is to run the SIP for a period longer than 1-2 years. Looking at SIP returns in shorter timeframes is going to be misleading and will not show you what its benefits are. As said above, SIP returns in ICICI Prudential Bluechip started in January 2016 would be 9% today. A SIP started in 2015 would be 10%, and one started in 2012 would be 12.6%.
SIPs need to be run across market cycles for them to deliver. SIPs run through a rising market will average costs up. They need to be run through a market correction to bring costs down. Consider the period from January 2010 to January 2019. We’re taking this timeframe as it is long enough, starts at a market high point and has corrective phases in 2011 and 2013. Let’s say you had SIPs in HDFC Midcap Opportunities. You stopped the SIP from March 2011 to mid-2012 and again from May 2013 to May 2014 (we’re adjusting for the fact that you wait for correction to get underway before worrying into stopping SIPs). In such a case, your average cost per unit would have worked out to Rs 27.7. If you hadn’t done such stopping, your average cost per unit would have been Rs 23.7.
If you have SIPs begun in low times for the market, you already are at an advantage since you’re buying cheap. When markets pick up, the payoff is much more. But you certainly do need to wait for markets to pick up for returns to come by.
Quick aside – do remember that SIP returns, absolute returns for the SIP, and fund returns are different. As SIPs involve buying at different prices at different times, you cannot take the simple absolute returns (value of investment less the cost) to be the SIP’s returns. Nor can you take a fund’s returns (which are returns for a single period between two dates) to be the SIP’s returns. SIP returns are calculated using the XIRR formula, which accounts for the fact that there are different price points and periods within an investment.
An SIP is meant to build wealth gradually.
Removing the need to time investments to market lows and averaging costs down are secondary benefits of an SIP. The main benefit is discipline in savings and allowing smaller investments to build slowly up to a large sum. It is much more manageable to sock away Rs 10,000 a month to reach Rs 22 lakh in 10 years than it is to invest Rs 7 lakh today to get the same amount (assuming 12% annual returns).
Setting up a SIP ensures that you compulsorily invest each month instead of forgetting to do so in the stress of the daily grind. Trying to manage SIPs by stopping during corrections or rallies simply means that you reduce your investments. Lower investment equals lower wealth. Take the HDFC Midcap example above where you stopped SIPs for a few months in 2011 and 2013. In that example, for every Rs 1000 SIP, you would have invested Rs 28,000 lesser over the course of 2010-2018. For this lower amount, the value of your wealth would be lower by Rs 87,000.
So, by stopping SIPs, you may fall short of your requirement, you may have to invest more at a later date which can cut into your lifestyle, you may have to take unnecessary risks with your investments.
The bottomline – SIPs are a way of investing regularly each month over a period of time to build enough savings to meet a financial goal. Keep it straight!