Do investors really need to look beyond plain vanilla SIPs?

6 Nov 2023 , 09:26 AM

Why are SIPs such a good long term story?

By now, most of you are already familiar with the SIP story. You weave a thread of it each day and finally it is just too big. In short, by investing a small sum in mutual funds each month over a considerably long period of time SIPs provide multiple advantages. Firstly, SIPs instil discipline in people about saving. People are habitual spenders, unless there is a discipline and compulsion to save. That is where SIPs come in handy. Secondly, SIPs are great value compounders and the longer the time frame, the greater is the wealth created in the process. 

Thirdly, and this is very critical, the SIPs give the unmatched advantage of rupee cost averaging. Here is what it means. The bad news is that it is practically impossible to time the market. The good news is that you don’t need to time the market. A product like SIP gives more value in rising markets and more units in falling markets. Over a longer time-frame, the cost of holding the SIP reduces and the yield is up. The fourth big advantage of SIP is that they are most amenable to financial planning. You can just set long term goals like retirement, child’s education, second home etc and peg SIPs to each goal. It makes your task a lot simpler.

Understanding the incremental power of SIPs

To understand the power of SIPs, it is essential to understand the incremental value creation by SIPs. The table below is rather interesting and revealing. It considers a simple regular SIP of Rs1,000 per month over different time frames from 2 years to 30 years. The money is assumed to be invested in an equity SIP and the average CAGR yields are assumed at 14%, over all the time frames.

Period In Years	Monthly SIP (in Rupees)	Total Months (in Rupees)	Total Outlay (in Rupees)	SIP Value (in Rupees)	Value Gain (in Rupees)	Incremental Gain (in Rupees)
2 Years	1,000	24	24,000	27,834	3,834	–
4 Years	1,000	48	48,000	64,603	16,603	12,769
6 Years	1,000	72	72,000	1,13,174	41,174	24,571
8 Years	1,000	96	96,000	1,77,335	81,335	40,161
10 Years	1,000	120	1,20,000	2,62,091	1,42,091	60,756
12 Years	1,000	144	1,44,000	3,74,054	2,30,054	87,963
14 Years	1,000	168	1,68,000	5,21,954	3,53,954	1,23,900
16 Years	1,000	192	1,92,000	7,17,329	5,25,329	1,71,375
18 Years	1,000	216	2,16,000	9,75,416	7,59,416	2,34,087
20 Years	1,000	240	2,40,000	13,16,346	10,76,346	3,16,930
22 Years	1,000	264	2,64,000	17,66,711	15,02,711	4,26,365
24 Years	1,000	288	2,88,000	23,61,636	20,73,636	5,70,925
26 Years	1,000	312	3,12,000	31,47,525	28,35,525	7,61,889
28 Years	1,000	336	3,36,000	41,85,674	38,49,674	10,14,149
30 Years	1,000	360	3,60,000	55,57,056	51,97,056	13,47,382

The most important and interesting data point in this table is the last column. It calculates the incremental gains for every period of 2 years. When your SIP time frame moved from 2 years to 4 years, the incremental gain was just Rs12,769 crore. When the SIP time frame moved from 16 years to 18 years, the incremental gain was Rs2,34,087 crore. However, when the SIP time frame moved from 28 years to 30 years, the incremental gain was Rs13,47,382 crore. One can argue that this is due to the time value of money and that is also technically correct. But that is not the point. The point is that as your SIP is held for a longer period, the incremental benefits of every additional year of holding grows exponentially. That is the real message, which underlines why SIPs must be for long term. 

Remember, the above is a plain vanilla SIP and, quite often, the plain vanilla SIP may not give a proper solution to changing market conditions, changing life situations and the demand of your own goals. It is necessary to look beyond plain vanilla SIPs.

What these plain vanilla SIPs are all about?

A plain vanilla SIP, as the name suggests is just investing a fixed sum of money into a mutual fund over a long term. Believe it or not, that is a very effective strategy. Here are the two most popular types of plain vanilla SIPs.

• Let us look at the most popular plain vanilla SIP, which is the Regular SIP. The illustration above to understand the power of incremental value creation by SIPs, is an example of a Regular SIP. Here is what the Regular SIP is all about. In a Regular SIP, the investor invests a fixed amount of money at regular intervals on a set date. The SIP frequency can be weekly, fortnightly, monthly, bi-monthly, or quarterly; although monthly SIPs are the most popular. They are also the most pragmatic since income flows for most people are monthly and the timing of the SIP can be made to sync with the timing of income flow. Typically, the investor will mention the SIP duration, instalment amount and frequency when opting for the SIP. Regular SIPs have to be renewed before the tenure is completed as in the absence of any confirmation, the SIP is automatically terminated by the fund, after due intimation to the investor.

   

• The tenure of the SIP can often be a problem since it results in a high ratio of SIP expiries, which are not renewed. The push factor always better than the pull factor. That is why, an interesting option is the Perpetual SIP. This is a regular SIP with no need to renew after a fixed tenure. It just continues perpetually till it is cancelled by the investor. In this case, while filling the SIP application form, the investor has to select the tenure of the SIP as a perpetual SIP. Under the current practice, if no tenure is specified, then the SIP automatically becomes a perpetual SIP. In other words, the SIP will continue for a duration until the investor provides instructions to the fund house or the manager to stop the investments. Perpetual SIPs are a good option for investors not wanting to limit their contributions with a maturity tenure. This ensures that the investor stays invested for longer durations.

That takes us to the next level of SIPs that go beyond the plain vanilla.

Smart SIPs are an improvement over regular SIPs

A slight improvement over the plain vanilla regular SIPs are the smart SIPs. They tweak the SIP amounts either based on a rule or based on discretion. Here are 3 popular types of smart SIPs.

• The most basic form of a smart SIP is a rule based Top-up SIP. Today, a number of mutual fund houses are offering these top-up SIPs to garner greater wallet share from the investor. Here is how the top-up SIP works. A top-up SIP is also called a step-up SIP and it adds more flexibility to the recurring contributions. Typically, people see their incomes increase over time. If you use a regular SIPs, you are not doing justice to your additional savings potential. That is where top-up SIPs come in handy. In a top-up SIP, you can specify an annual increment to the SIP. Such increments can either be percentage based or they can be rupee based, although the latter is a lot simpler and easier to plan and implement. If your fund offers this facility, it is a good idea to opt for this kind of a top-up SIP. Typically, if you start with a SIP of Rs10,000 per month with an annual top up of Rs1,000; then the monthly SIP becomes Rs11,000 at the end of 1 year, Rs12,000 at the end of 2 years and so on.

   

• The second type of smart SIP is the flexible SIP which gives investors the opportunity to alter their SIP investment amount. It is also known as Flexi SIP. In Flexi SIP, the intimation has to be given to the fund house well in advance and most AMCs insist on 1 week notice at the bare minimum. Alternatively, investors can enhance the SIP amount when the index P/E falls below a certain level or reduce the SIP when the P/E rises above a threshold. Of course, these are complex decisions. That is why; the flexible SIP or Flexi SIP is meant for savvier investors who have the time to regular monitor their mutual fund portfolios and market data.

   

• A slightly improved version of the Flexi SIP is the Trigger SIP. Once again, this is better suited to investors who are slightly more savvy and able to understand and interpret the market dynamics. Under the Trigger SIPs, investors can set their SIP start date or redeem or switch their SIP once the selected event occurs. The trigger can be set to any event, like a particular index level or NAV of the fund or capital appreciation or fall in value. There are two things here. Investors must be fully capable of handling the consequences of their decision. Secondly, this is not recommended for SIPs that are linked to long term goals like retirement or children’s education which are considered mission critical.

Smart SIPs are an improvement over plain vanilla regular SIPs, but they are best administered and run by savvier investors. It is not everyone’s cup of tea.

Hybrid SIPs that go beyond the ordinary

Hybrid SIPs actually add some non-SIP feature to these SIPs and make them special. Currently, in the Indian context, there are two very popular such hybrid SIPs. The first is SIP with Insurance. This is typically offered by mutual fund AMCs that may also have a group insurance company and this is how it works. The AMC offers insurance cover if an investor opts for long-duration investments. The typical cover is up to ten times the first SIP amount, and it gradually increases with time. However, this feature is only available for equity mutual funds. It does not impact the performance of the fund, but for child plans, it can take care of the remaining tenure of the SIPs if a basic minimum time period is completed. The second type of hybrid SIP is Multi-SIP. Here is how it works. The multi-SIP allows investors to invest in multiple schemes of the same fund house through a single instrument. This could include equity schemes, hybrid schemes and debt schemes. Investors can have something like a multi-asset allocation fund with limited paperwork. 

Goal based SIP management

For most investors, the regular SIPs do a good enough job and other SIPs like flexible SIPs and Trigger SIPs are for investors who have the appetite for higher risk. Retail investors should ideally persist with plain vanilla SIPs or, at best, they can look for top-up SIPs. More important is how they actually realize the benefits of SIPs through SIP management. We look at 2 such cases were.

1. The first  is the use of systematic withdrawal plans (SWP). These are the reverse of a SIP and entail the programmed withdrawal of money from the corpus created through SIPs. Quite often, the SWPs can commence even before the SIP is fully complete so that the gains made can monetized gradual basis, thus making it tax smart.

    

2. The second is the use of systematic transfer plans (STP), which can be used in case of lump-sum flows. Any lumpsum amount can be invested in a liquid fund and gradually swept into an equity fund in the form of SIP. This ensures that even on a lump-sum inflow, investors get the benefit of rupee cost averaging.

The moral of the story is that SIPs can still create a lot of value over the long term and many of the smart SIPs may be tough to implement and value add my be debatable. A better option would be to focus on SIP management, which is the appropriate use of SWPs and STPs. That is a good place to start the SIP journey.