Can SIPs in equity mutual funds help to avoid losses?

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Advertisements with the tag line ‘Mutual Funds Sahi Hai’ have become popular among retail investors. Such awareness programs are run by Association of Mutual Funds of India (AMFI) and individual fund houses to educate retail investors. Investors now know that one does not need a huge lumpsum amount to invest in the stock markets. Even small amounts as low as Rs.500 can be invested in mutual funds on a regular basis to create long term wealth through SIP (Systematic Investment Plan). This is evident in the recent SIP inflows for the month ended December 2019. Retail SIP inflows topped the highest ever figure of Rs.8022 crore in a single month in December. These were also 29 per cent higher compared to December 2018.

But this trend also warrants for some amount of caution. Many investors do not completely realise the risks associated with SIPs. The usual thing that investors know about SIPs is that they help average out the cost of investment.

Let me illustrate this with an example:

Suppose you invest Rs.5000 per month in a mutual fund through SIP. The prevailing (net asset value) NAV is Rs.50 per unit, so you will get 100 units. Next month, the NAV goes up to Rs.75 and you get 66.67 units. In the third month, the NAV rises further to Rs.90, so you get 55.55 units. In the fourth month, the NAV falls to Rs.70, you get 71.4 units. And in the fifth month, the NAV is Rs.95, you get 52.6 units. At the end of 5 months, you have invested Rs.25,000 and got 346 units at an average price of Rs.72.2. So, even though the price went up or down every month ranging from Rs.50-90, your average price is Rs.72.
Simply put it, the average price of investment at the time of sale should be greater than Rs.72 for you to make a profit on it.

So, irrespective of markets going up or down, your SIP investment happens at a pre-determined date. Hence, the futile effort of timing the market is out of question and you can avoid the market noises.

Now let me dispel a few myths about SIPs.

Firstly, the most common query I get on SIPs is ‘which is the best SIP to invest in?’. To clarify, there is no good or bad SIP here. SIP is not a type of mutual fund. SIP is just a mode of investment in any mutual fund.

Secondly, the general notion is that SIP reduces investor risk. This is completely untrue. SIP merely manages your risk as you ride out the volatility and average out your cost through regular investments at very high market levels. But this can also work the other way as markets are not unidirectional. When markets are consistently falling, you also miss the opportunity of investing at potentially low levels. The 2008 market downturn is a classic example when the Global Liquidity Crisis happened. Many retail investors stopped their SIPs to cut down losses as markets were falling and making new bottoms every day. There were few who averaged out by continuing SIPs. And there was a rare breed who invested a big lumpsum (in one shot) at low levels and reaped huge gains few years down the line. In that context, SIP plays a limited role in managing risks.

Thirdly, investors commonly perceive that SIPs are loss proof. Since investments are averaged out during upturns and downturns, SIP returns cannot be negative. This is also not true. If you invest in the wrong funds which are not in sync with your risk appetite or not professionally managed, you are likely to incur losses. Blindly investing in mutual funds recommended by your friends/relatives without proper research is likely to end up in the red, be it through SIP or lumpsum investment. Another scenario wherein you can incur a loss through SIP is if you withdraw from a fund in an untimely manner within a short period of time. This happens when you do not give the fund sufficient time to perform and suddenly exit fearing more losses.

To conclude, SIP merely manages your risk and prevents you from investing lump sum at market peaks, thus encouraging you to spread out the risk over time. Having said that, SIP is still the best mechanism for retail investors to build long term wealth in the stock markets. Do not stop your SIPs when markets are on a downturn and your returns show red. This is the worst thing you can do to your portfolio. It is like you prefer to buy when markets are expensive and do not want to purchase when they are cheap. Give your SIP investment at least 5 years. Best still, align it with your financial goals and stay invested till they are met.

Remember, risk is associated with every investment. It is important to be aware of the risks.

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