God of SIPs will protect you at tough times

One of the less foreseeable results of the past two years’ turmoil on the stock markets has been that many investors are loudly questioning the efficacy of SIPs. One such person I met — a typical case — started by claiming that SIPs were no good and that he had barely broken even on SIPs in a number of funds over the past four years. This seemed odd because the funds he named had done quite well. I quizzed him further and it turned out that back in 2008, when the markets had crashed, he had immediately stopped all his SIPs. However, he had restarted all the SIPs in August 2009.

Observant readers would have realised that this investor had basically done it to himself. He had invested in a manner which was guaranteed to shield himself from any possibility of making money. Unfortunately, this problem is way too common.

The underlying problem is the increasing belief among people who skim the financial media that SIPs are a magical device, akin to the blessings of a godman and are thus guaranteed to produce profits no matter when. They can stop whenever they feel and start whenever they feel like and the God of SIPs will protect them.

The basic idea behind SIP, what the Americans would call SIP 101, is that while the general direction of an investment — a fund or even a stock — is upwards, it is not possible to reliably predict the actual fluctuations that it may undergo as part of its general trend. Instead of trying to time one’s investments, one should regularly invest a constant amount. As time goes by and the investment’s NAV or market price fluctuates, this will automatically ensure that when the price was low, you ended up purchasing a larger number of shares or units.

Eventually, when you want to redeem your investment, all the units are worth the same price. However, because your SIP meant that you bought a larger number of units whenever the price was low, your returns are higher than they would have been otherwise. That’s the way it works. Usually. However , you have to allow it to work by going on investing when the market is low. That’s the most important part.

Generally, over a long period of time, the ups and downs of the market will ensure that SIP has the better returns.

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