SIP, or the systematic investment plan, is a heavily advertised methodology not only by the investment industry which includes various mutual fund houses and asset management companies, but even the regulators are at times seen advertising the SIP method. However, it is full of various scenarios and outcomes, and many of those can be loss-making, or not that good, for bulk of the investors who blindly follow SIP-based methodology. This article looks at the realistic scenarios to explain how and when SIP fails, and why common investors should avoid it blindly.
How SIP Investment Method Works?
Systematic Investment method (SIP) promotes regular fixed amount investments each month in the same stock or mutual fund over long periods of time. It attempts to benefit by allowing an average buy price to the investor, which prevents the investor from buying at random prices or buying at high price at lump-sum. This way, SIP claims to be better as it offers an 'average' buy price. However, things are different in reality. Let's look at it with an example.
Let's say you decide to invest in a particular mutual fund each month through SIP method. Say you decide to invest $1,000 on the first day of each month, and receive whatever mutual fund shares/units are available at that day's NAV value. The same SIP method can be followed for investing in any stock of your choice, like Apple Inc. (AAPL) or Microsoft Corp. (MSFT).
Assume that your choice of mutual fund or the stock turns out to be correct. The fund or stock starts at a price (NAV) of $100 on 1-Jan, and it doubles in value in one year's time to $200. Fantastic returns of 100% in a year! and the mutual fund advertisements will scream that they have beaten the market and generated 100% returns!
But then, what about your SIP investment in the same mutual fund during the same period. The journey from the price of $100 to $200 has been a steady one. Here's is how your investments will go over the one-year long period with SIP investments made on the first of each of the 12 months.
| SIP Date | NAV | Invested Amount | Units/Shares Allotted| 1-Jan-19 | 100 | 1000 | 10.00 | | 1-Feb-19 | 109 | 1000 | 9.17 | | 1-Mar-19 | 117 | 1000 | 8.55 | | 1-Apr-19 | 125 | 1000 | 8.00 | | 1-May-19 | 133 | 1000 | 7.52 | | 1-Jun-19 | 141 | 1000 | 7.09 | | 1-Jul-19 | 150 | 1000 | 6.67 | | 1-Aug-19 | 167 | 1000 | 5.99 | | 1-Sep-19 | 175 | 1000 | 5.71 | | 1-Oct-19 | 182 | 1000 | 5.49 | | 1-Nov-19 | 189 | 1000 | 5.29 | | 1-Dec-19 | 195 | 1000 | 5.13 | | Total | | 12,000 | 84.62 | |
Based on the above, the total investment made by the individual is $12,000 over the 12 month period, and he gets a total of 84.62 units/shares of the mutual fund/stock. Dividing the former with the latter, the average buy price of the investor comes to 12,000/84.62 = $141.82. Assume that on 1-Jan of the next year, the price of the mutual fund hits double the value of $200 against the year ago starting price of $100 making it double.
How SIP Investments Fail?
Now consider your average buy price per unit. The mutual fund is absolutely right in claiming that it has generated a healthy and market beating returns of 100% as its NAV rose from $100 to $200 in one year. But what about the SIP investor? Since his 12-month long SIP journey resulted in multiple investments each month, his average buy price is no $100, but a higher $142.82. Against the final price of $200, the returns generated are (200/142.82)-1 = 41% only.
Compare this against the mutual fund performance of 100% returns, and this is way too low.
Now let's consider other cases as this was a case of one way upward price rise.Does SIP Investments Work in all scenarios?
Assume that the price of the mutual fund remains more or less stable, that is - in the -20% to +20% range all throughout the year, which translates to $80 to $120 from the starting price of $100. What happens now to your SIP investments?
| SIP Date | NAV | Invested Amount | Units/Shares Allotted| 1-Jan-19 | 100 | 1000 | 10.00 | | 1-Feb-19 | 109 | 1000 | 9.17 | | 1-Mar-19 | 117 | 1000 | 8.55 | | 1-Apr-19 | 112 | 1000 | 8.93 | | 1-May-19 | 98 | 1000 | 10.20 | | 1-Jun-19 | 88 | 1000 | 11.36 | | 1-Jul-19 | 82 | 1000 | 12.20 | | 1-Aug-19 | 99 | 1000 | 10.10 | | 1-Sep-19 | 105 | 1000 | 9.52 | | 1-Oct-19 | 112 | 1000 | 8.93 | | 1-Nov-19 | 118 | 1000 | 8.47 | | 1-Dec-19 | 110 | 1000 | 9.09 | |
In this case, your total invested value still remain the same $12,000, but your average price per unit/share comes to around $103. But then, the year end value is $120, which translates to a mere 16.53% return on your total SIP average per share price. The actual mutual fund has performed better, as it rose from 100 to 120, which is 20% compared to SIP's 16.53%.
Similarly, say the MF unit price goes downward in a free fall as follows.
| SIP Date | NAV | Invested Amount | Units/Shares Allotted| 1-Jan-19 | 100 | 1000 | 10.00 | | 1-Feb-19 | 95 | 1000 | 10.53 | | 1-Mar-19 | 90 | 1000 | 11.11 | | 1-Apr-19 | 85 | 1000 | 11.76 | | 1-May-19 | 80 | 1000 | 12.50 | | 1-Jun-19 | 75 | 1000 | 13.33 | | 1-Jul-19 | 70 | 1000 | 14.29 | | 1-Aug-19 | 65 | 1000 | 15.38 | | 1-Sep-19 | 60 | 1000 | 16.67 | | 1-Oct-19 | 55 | 1000 | 18.18 | | 1-Nov-19 | 50 | 1000 | 20.00 | | 1-Dec-19 | 45 | 1000 | 22.22 | |
In this case, say the year end price of the MF was $65. Against the average per unit buy price of $ 68.19, it is actually giving you a loss during the investment period. One may need to wait till the price shoots up above the average buy price to realize any gains even with SIP. However, one benefit of SIP during this downward fall is that one always gets a lower average price as the monthly price keeps hitting the lower levels, so it is fairly high-chance that once the MF or stock price starts rising, it will give big profit as the average buy price is lower.
However, it still causes short-term losses to the SIP investor.In summary, one must remain cautious about the SIP investments. Blindly doing SIP even in the best performing stocks or mutual funds may not necessarily yield good returns for the SIP investor.
If SIPs are not effective and efficient, why are they popular?
Billion-dollar question!
They are NOT popular, but they have BEEN MADE popular by the industry as it benefits the industry stakeholders more than it benefits the investors!
In reality, SIP hits upon investor's psychology and takes advantage of that. SIPs are designed to make one commit multiple recurring payments over long run. It earns and guarantees good commission for the agent, as well as guarantees a steady recurring flow of investment to the fund house. That's why they are heavily promoted by all in the investment industry, despite being inefficient!
The poor and ignorant investor does not know for long years that he is not really earning anything effectively!
Even if he realizes a few years later, it is psychologically very difficult (almost impossible) for an average investor to cut off the SIP and book a loss. That's what the SIP, the mutual funds, and the investment industry banks upon, and keeps promoting it!
Be knowledgable, be realistic, look at positives and negative before getting into SIP based investments.