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When SIP doesn't work... May 20, 2011
Novice investors should try and avoid the four traps discussed in the article.
Author : Dhanashri Rane


When SIP doesn't work...

We have introduced SIPs in our previous blog post. Despite the advantages of SIP, it may happen that SIP may not reap the desired fruits.

The situations that one can and should avoid are:

Scenario I: Abrupt withdrawal during the SIP Period

If you are investing in SIP with a time horizon of approximately one year, and require cash intermittently from the investment, then the returns may not be attractive.

Example: We calculated the returns from our recommended, HDFC Midcap Opportunity Fund for a period of one year and compared it with the benchmark, BSE Midcap Index for the same period. In 2010, the mid-cap sector had a good run before correcting sharply towards the end of the year.  A 12-month SIP beginning on 10 January 2010 gave a return of 2.06% as against the benchmark performance of 0.67%, at the end of all installment payments.
Even though the SIP has outperformed the benchmark by a decent margin, the returns are not substantial. Hence, one should set up SIP and hold it for long term as any other equity investment.

Therefore, plan out your cash flow requirements and accordingly, set aside an amount that you could support even as you may have other liabilities or contingencies.

Scenario II: Terminating SIP when the markets tank

The mutual fund industry witnessed numerous SIP termination requests from retail investors during the 2008 financial crisis. The principle for investing in SIP is to invest regularly and not to time the market.

Example: We looked at the performance of SIPs started from 2008 and evaluated their performance over the last 4 periods. From the peak of 2008, the Indian equities tumbled down and later recovered in 2009. Thereafter, markets witnessed steady returns until inflation and expensive valuations resulted in the market fall. If one had stayed through the market crash and invested regularly, the return from SIP would be significantly better than one time investment.

Table 1 compares the corpus generated by putting Rs. 1000 every month through SIP and Lump-sum investing.

Scheme Name

Start Date

End Date

Profit-SIP (INR)

Profit- Lump-sum (INR)

CAGR (%)

Category: Benchmark 

BSE MIDCAP

10-Jan-2008

11-Apr-2011

12,262

-9,817

17.87

CNX Midcap

10-Jan-2008

11-Apr-2011

15,471

-3,521

22.27

CNX Nifty Junior

10-Jan-2008

11-Apr-2011

18436

-3,080

26.25

 Category: Recommended Schemes

DSPBR Small & Mid Cap (G)

10-Jan-2008

11-Apr-2011

23,333

4,825

32.66

HDFC Mid-Cap Opportunity (G)

10-Jan-2008

11-Apr-2011

22,028

7,358

30.97

IDFC Premier Equity-A(G)

10-Jan-2008

11-Apr-2011

21,579

7,458

30.39

Clearly, the SIP investors have gained more. Hence, market corrections should be looked upon as investing opportunities.

Scenario III: Investing for short term - Attracts tax and volatility

In your financial plan, the SIP should be aligned to medium to long-term objectives. One can also take exposure to high beta sectors or themes such as energy, metals, and infrastructure – power through the SIP route.  This way, you can get a marginal allocation to sectors or themes that may be otherwise quite risky.

Silver delivered almost 80% returns in 2010 but, tanked by 28% in a week’s time (ending 5 May 2011). Thus, investing for short-term may not give you the benefit of averaging out the volatility which is inherent in the markets. Also, the return from high risk securities is highly uncertain during the short phases.

Moreover, you will also attract a short-term capital gains tax of 15% which is applicable for an equity holding of less than a year. Paying a tax on marginal returns would further reduce your end returns.

Scenario IV: SIP in a rising market

The concept of Rupee Cost Averaging will not work in a rising market. This is because the NAV would be on an upward trend on a month-on-month basis. So, the cost of investment would increase with every monthly installment.  

During periods of secular Bull Run, investors can consider current valuation vis-à-vis other asset classes or countries, evaluate future prospects and take a call based on their risk appetite and time horizon. Accordingly, they can diversify into other assets which have a low correlation to equities like fixed income.

In contrast, when markets correct and valuations are at attractive levels, aggressive investors should opt for top-ups and increase their allocation towards fairly valued assets.

Conclusion

We can never guesstimate from a given point, whether the market would keep rising, remain range bound or fall. However, SIP remains the simplest tool towards long-term wealth creation.

Chart 1 emphasizes the multi-fold increase in assets from the SIPs of INR 1000, started in April 1999 till March 2009, across 120 installments. We have considered a large cap fund - Franklin India Bluechip Fund and a mid cap fund - Reliance Growth Fund which have grown to around INR 267,000 and INR 475,000 (till date) respectively.

Even though the markets are currently trading at low levels compared to the recent peaks, the return from a ten year investment perspective is enormous. Both these funds have given a CAGR of 17.51% and 31.97% respectively.  By end of April 2011, these SIP investments have almost doubled and quadrupled. 

Thus, novice investors should try and avoid the four traps discussed above and be happy investing!

source: Accord


Disclaimer: iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's scheme information document including statement of additional information. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer on the website.Please read our disclaimer in the website. Risk Factors: Mutual funds, like securities investments, are subject to market risks and there is no guarantee against loss in the Scheme or that the Scheme’s objectives will be achieved. As with any investment in securities, the NAV of the Units issued under the Scheme can go up or down depending on various factors and forces affecting capital markets. Past performance of the Sponsor/the AMC/the Mutual Fund does not indicate the future performance of the Scheme. The name of the Scheme does not in any manner indicate the quality of the Scheme, its future prospects or returns. Please read the Statement of Additional Information and Scheme Information Document carefully before investing.



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