Systematic investment plans (SIPs) have hit off in a big way in India. According AMFI, average monthly flows into SIPs are Rs8,300cr; largely retail money is invested in diversified equity funds, multi-cap funds or ELSS funds. But what do you do when markets are uncertain and likely to fall sharply? Should you continue with your SIP or temporarily sit out and wait for the markets to stabilize?
While there are no clear answers, an SIP is essentially a passive approach to long term wealth creation. The purpose of SIP is to avoid timing the market. That is why persisting with a SIP for a longer period makes sense. Here is why!
1) SIPs are designed to even out volatility in the long run
The SIP is designed to invest regularly in a fund on a particular date. The idea is that when the prices go up, the investor gets more value via NAV. When the markets are lower, the investor gets more units. This combines to give the SIP investor a unique advantage over a longer time frame. SIPs are all about making time work in your favour. Discontinuing the SIP goes against this basic principle.
2) SIPs are normally pegged to long term goals
How and why do you structure SIPs in your investment portfolio? The process begins with laying out your long term goals. Once the goals are laid out, then you work the monetary requirements at the end of the goal period. Based on this expected corpus, you design SIPs to reach these goals. That means, when you discontinue SIPs, you actually compromise on your long term goals.
3) SIPs rely on the power of compounding and that needs commitment
The power of compounding is not too hard to fathom but the impact on your wealth is huge. But there is a basic condition. SIPs work when the power of compounding works to the full extent. Power of compounding only works when you stay invested and intermittent cash flows are reinvested in the SIP. That is only possible when you commit yourself to the SIP for the long term. When you terminate the SIP in between, the compounding factor is lost out and the SIP is unable to deliver the desired returns.
4) SIPs instil discipline because they sync with your income flows
One of the less appreciated advantages of a SIP is that it is a discipline that creates wealth. If you wait to create a corpus and then invest the money, then you will probably end up waiting for ever. SIPs force you to do two things. Firstly, they impel you to look at savings as a target rather than as a residual item. Plan your savings and adapt your budget accordingly. Secondly, since inflows are periodic, SIP helps you to synchronize outflows with inflows. That does not impose a heavy burden on your finances and makes investment a process.
5) SIPs work, proof of the pudding lies in the eating
To fully appreciate why to persist with SIPs, let us look at a live example. To avoid fund manager bias, let us look at the index versus an index fund. If you had invested lump sum at the first Nifty in January 2008, your annualized return till the time the Nifty touched 10,000 in mid 2017 would have been 4.8% per annum. What if you had done SIP on an index fund, instead?
Clearly the SIP on HDFC Index Fund would have yielded an annualised return of 10.10%. That best explains the merits of persisting with a SIP approach to investing over the longer term.