Systematic Investment Plan (SIP) enables you to buy mutual fund units periodically. Rupee-cost averaging is one of the widely known benefits of a SIP. Instead of buying 10 units at one price, you would be buying 1 unit at a time, spread over a period at different prices. Theoretically, this can help reduce your overall costs as you may be buying some units at cheaper levels.
But when the market is going higher and higher every month, you may wonder why you have to use the SIP route. ‘Am I not buying at higher prices in each installment?’, you may ask.
Yes, like in a stock market that is steadily up, as we have seen in 2017, the chances are, you are actually buying at higher prices and raising your average cost. Then why do we still recommend SIP as the right method of investment?
Timing the market
The first and very simple reason is that we don’t know for certain where markets will move next. That SIPs don’t work in a bull market is logical. But a bull market or a bear market is known in hindsight. Peaks and troughs are recognizable patterns only once they are past.
You might think the market seems to be in a continuous upward trend and go for a lumpsum investment. However, it might take the opposite course leaving you out of the averaging opportunity. Or you might think the markets are at a peak and wait for a fall to invest. But the markets might continue rising and you will miss out on the growth.
The graph shows the 1 year return of S&P BSE Sensex at different months in the past 5 years. See how the returns move. There is no way to guess that March 2015 was a Sensex peak and it would correct up until 2016. If you stopped your SIP, you would have lost averaging opportunities. It was not clear that September 2013 was a market bottom and markets would rise for two years after that. At this point, lump-sum would have been timed right. But these patterns were discernible only in hindsight.
The second graph shows the S&P BSE Sensex movement from 2013 till now. Here we can see that the market has continued to move up after a small correction. If you thought markets were at a high at any point in these years and held off your SIPs, you would have missed much of the rally. Had you stayed the SIP course throughout, you would have invested at several points in the downtrend which would have paid off when the market began rising again. 2017 is a great example of when conventional metrics pointed to a market high but the rally still went on.
The second reason is the purpose of an SIP, which is to maintain discipline in investments and not get bogged down by trying to time markets. By trying to switch between a lump-sum and an SIP or even pausing your SIP, you’re defeating the entire purpose of having an SIP in the first place. Know that SIPs are meant to be run across market cycles and not just for a year or two. This will help capture both the boom and the bust.
By stopping SIPs, you would merely be stopping your investment habit. This is the third reason to refrain from pausing SIPs because it directly hurts your wealth creation. The lesser you invest, the lower your eventual wealth is going to be. You may find yourself short of the required corpus and you will have to find ways to make it up later.
What a SIP does, when run for years together is to ensure two things. One, you minimize market timing errors – if the market goes up, you don’t have an opportunity loss and if it corrects, you average down your costs. Two, and more important – you are sufficiently investing for your goal; for most of us, SIPs enable investing small sums as and when we have it towards building a large corpus; investing a lump sum to create the same corpus would require a far larger amount than we have at hand. The bottomline is that, compromising on your SIP will only leave you short of your goal.
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