Why do SIPs deliver high returns?

Systematic Investment Plans or SIPs are gaining popularity owing to ad campaigns such as Aditya Birla Sun Life Mutual Fund’s - Mutual Funds Sahi Hai or HDFC Mutual Fund - Baat Bane Kishton Mein. Sometimes SIPs are confused as a product. We come across questions like- How do I invest in SIP? But SIP is not a product in itself, it is a tool that allows an investor to invest a fixed sum of money in a mutual fund of their choice. SIPs can be set to be paid weekly, monthly, or quarterly. They bring a sense of financial discipline to the life of an investor. For example, you decide to invest in a mutual fund every month. You might forget to invest one time, or if the market is upset you might put off investing all. Conversely, you might even invest more if the market seems promising. SIPs eliminate all these uncertainties and automate the process for you. Every month a fixed specified amount set by you is automatically invested. Lumpsum investments are another avenue to explore while investing. If an investor wants to invest all the money that is currently at his disposal at one go they can invest it as a lump sum investment. So, here comes the dilemma of choosing between SIP or lumpsum for investment. Lumpsum investments are for big players who have a large amount of money that they can invest for a long period of time. But for most people who are new to investing or have a limited salary, SIP is an easier way to dip your toes in the investing pool. When you opt for SIP in a mutual fund, you automatically diversify your investment because mutual funds hold a variety of investments in different companies or sectors. When you are starting out, you may not have the requisite analytic skills, knowledge, or time to do so. Here mutual funds help by pooling your money with other investors and the decisions are led by seasoned portfolio managers. The ease of buying and selling fund units makes mutual funds an attractive package. Lastly, there is a fund for different types of people. A young investor inclined towards risk or a mid-career investor trying to balance risk and return or an investor nearing retirement who is averse to risks. There are a number of funds to choose from.

(Source: Unsplash)

There is no absolute reason why SIPs are better than lumpsum investments. But it is observed that over a long period of time under relatively normal circumstances, SIPs will do better than lumpsum investments. Let us understand why that happens. SIPs are invested at a predetermined interval with a fixed amount decided by the investor. This removes uncertainties and burdens from the investor. With SIPs the investors automatically buy more units when the market level is low and vice versa. This is called the rupee cost averaging. A SIP allows the investor to invest in different market cycles. They don’t have to take their time and decide whether to invest or not. This averages the prices of the units over a period of time and results in higher returns. Conversely with lumpsum investment, if you decide to invest a large amount when the market level is high, you will lose more if the market falls after that. So, SIPs give better averages over the purchase price of the units over a period of time.

SIPs keep the investor disciplined as it helps to be invested throughout the highs and lows of the market. People try to time the market. Investors wait for the lowest point to invest and the highest to sell. But it rarely happens that they get it correctly. This results in irregular investment behavior. If the market falls they stop investing entirely. SIPs keeps this psychology in check by keeping people invested throughout. So, if a person is financially disciplined and invests steadily then over a period of time they will get higher returns than a person that does not invest regularly. Moreover, SIP is better suitable for new investors. If you are someone who recently started your professional career then SIP would be a stepping stone to start your investing journey. It will help you get acquainted with the market and understand the working. After you gain experience with SIPs, you can venture into riskier investment instruments according to your risk appetite.

The power of compounding over time is powerful. Let us understand this with a small example. Ram and Shyam are two investors. At the age of 20, Ram invested ₹10,000 at 10 percent compounded annually. When he reaches 40 years, his investment will be a total of ₹67,275. Shyam, at the age of 30, invested ₹10,000 at 10 percent compounded annually. When he reaches the age of 40, his investment will be a total of ₹25,937. So, here we can see Ram has about 16 percent more wealth because he started investing early. This shows that the earlier they start, the more you gain in the end. So the phrase “Time is money” is really true. SIP will make sure you grow as a steady investor from the beginning.

While gathering data about various mutual funds and their performance over the last decade, some funds stand out due to their consistency. Before getting into that, investors should realize the fact that all funds are not designed for everyone. There are funds that might not match your risk-taking capacity. So one should do a proper analysis before committing their money into a fund. Mutual funds invest in various wealth instruments. All the data about their investments can be found on their respective websites or various finance websites that track the funds. Some of the popular and trusted websites are Economic Times, Moneycontrol, Value Research Online, Invest Guru, etc. Today, we have a myriad of apps available on our smartphones such as Groww, ETMoney, PayTM Money, Zerodha Coin, etc. that make investing super easy and smooth. They can guide you to open your Demat account and help you choose the right mutual fund. They also show the performance of the funds over a period of time. These apps have mutual funds sorted into various categories which makes the process easier and can get you invested in no time.

SIP of Consistent Compounders

Before putting in our hard-earned money, an investor should be thorough about the fund they are investing in. As a general rule of hand, one should invest in mutual funds that are performing consistently over a period of time. Imagine you are going for a roller coaster ride, you would want the ride to have cushioned seats and good safety standards so that you don’t come out bruised on the other side. Similarly, a consistent mutual fund allows you to ride the highs and lows of the market with ease. It is expected to be relatively less volatile than the market and other funds. Some of the consistent performers over the last decade are Axis Long Term Equity Fund, Mirae Asset Emerging Blue-chip Fund, Kotak Standard Multi cap Fund, ICICI Prudential Technology Fund, L&T Money Market Fund, etc.

Let’s take the example of the Axis Blue-chip Fund Direct Plan.

(Source: Groww (5-Year growth graph Axis Blue-chip Fund Direct Plan))

(Source: Groww (Axis Blue-chip Fund Direct Plan Fund Details))

Axis Blue-chip Fund Direct Plan-Growth is an Equity Mutual Fund Scheme launched by Axis Mutual Fund. This scheme was made available to investors on 01 Jan 2013. Shreyash Devalkar is the Current Fund Manager of the Axis Blue-chip Fund Direct Plan-Growth fund. The fund currently has an Asset Under Management(AUM) of ₹14,522 Cr and the Latest NAV as of 21 Jul 2020 is ₹33.21.

When you invest for five years or more, you can expect the returns to beat the inflation rate. But there will be ups and downs in the investment value. This fund is a large-cap equity fund. It invests in big companies. So these stock prices fall less, thus the fund tends to fall less. It is recommended to invest for more than five years if you are going for a large-cap fund. Before investing analyze the sectors in which the fund has invested. Funds that diversify their holdings will be better off if a particular sector fails.

(Source: Groww (Axis Blue-chip Fund Direct Plan Fund equity sector allocation))

Investments made during a rising market

If you would have made a lump sum investment of Rs. 12 lakh in ICICI Prudential Equity & Debt Fund during rising markets over say, from October 1, 2013, to September 1, 2014, and a monthly SIP of Rs. 1,00,000 in the same fund during the same period, the lump sum investment would have given you better returns.

Investment Mode - Lump-Sum

Amount Invested - ₹12,00,000

Compound annual growth rate (CAGR) - 52.58%

Time Period - 12 Months

Return - ₹17,68,466

Investment Mode - SIP

Amount Invested - ₹(1,00,000 *12)

Compound annual growth rate (CAGR) - 57.88%

Time Period - 12 Months

Return - ₹14,91,883

Investments made during a falling market

If you would have made a lump sum investment of Rs. 12 lakh in ICICI Prudential Equity & Debt Fund during falling markets say, over say February 1, 2015, to January 1, 2016, and a monthly SIP of Rs. 1,00,000 in the same fund during the same period, the SIP investment would have given you better returns.

Investment Mode - Lump-Sum

Amount Invested - ₹12,00,000

Compound annual growth rate(CAGR) - -0.73%

Time Period - 12 Months

Return - ₹11,91,999

Investment Mode - SIP

Amount Invested - ₹(1,00,000 *12)

Compound annual growth rate(CAGR) - -0.58%

Time Period - 12 Months

Return - ₹12,03,204

Times of turning tides

Now, what should we do during a time of crisis? How do SIPs fair in such adverse conditions? When the real world is going through bad times, market volatility increases, and many investors tap out. People start giving out advice not to invest lumpsum in this situation or stop paying the SIP amount altogether. This advice intends to mean well but often misleads people. This is because the fear that is being fed to the masses through media shadows logical thinking. People panic about their portfolios losing value and markets going down. But we must not forget that this is not the first time it is happening. The market has gone through similar harsh weather with high volatility and heavy losses. In 2008, during the global financial crisis, Sensex had almost halved. It was natural considering the fact that it was one of the worst crises in decades. But the investors who stayed in the market and kept investing came out as winners when the Sensex grew about four times in the next decade. In the time of crisis, investors should not panic and stop their SIP investments. As the market is fearful, the equity stock market is highly volatile. The difficult task should be left to the experts of the mutual funds. Investors should try to diversify our portfolio by putting our money in different mutual funds. This will help to capture the market when it is down. If the market rebounds or grows steadily you will be seeing healthy returns.

(Source: Unsplash)

The bottom line is SIPs make you a disciplined investor, rupee cost averaging lets you beat the market volatility, the power of compounding helps you grow your investments gradually over a period of time, and lastly they are easy to use. It is an amazing tool when you are just starting out and have a low-risk appetite. Having said that, no wealth-generating instrument is completely void of risks. If you think fixed deposits are totally safe, think what will happen if the country goes to war and the government collapses. One cannot predict the future performance of the market but risks can be significantly lowered by doing due diligence before investing in any instrument. Nevertheless, an investor should learn to trust their own instincts and be resilient to market emotions.

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Author - Abinash Baral

Content Writer at Escribo.