SIPs can give better returns in a volatile market because they gather more units over time.
In a rising market, most people get confused when investment advisers ask them to go for a disciplined approach towards investment – through systematic investments plans (SIPs). The reason: A lump-sum investment of Rs 60,000 can become Rs 1.2 lakh in two or three months. On the other hand, Rs 20,000 invested over three months might just become Rs 90,000 or Rs 1 lakh.
However, the importance of investing through SIPs can only be appreciated when we consider volatility. A comprehensive look at the situation can help investors understand this approach. Under an SIP, a regular sum of money is invested each month. It means that units are purchased in a staggered manner. This ensures that there is no break in the investment process and a corpus is built over time.
Compare this with lump-sum investment and the dynamics are completely different. You invest an X amount of sum at one point in time and, over a period of time, the money can double or treble.
Of course, there is the element of risk. If the market were to fall sharply, like it has since January, the lump-sum investment takes a bigger hit. The reduction, in case of a mutual fund, is equivalent to the fall in the net asset value (NAV) of the scheme.
On the other hand, if there is an ongoing SIP, investors actually end up gaining as only a part of their investment is eroding – the part that has been purchased when the NAVs were quite high. In spite of a falling market, investors buy units of the fund when NAV is falling. So, they gather more units of the same scheme. The best part is that when the market turns around a little, the investor in SIPs stands to make money much more quickly than a lump-sum investor because he has acquired more units over time.
Let’s understand with an example. Consider two investors, who want to invest Rs 60,000 each in a particular scheme. Whereas, one does it in a lump-sum fashion, the other does it over a year.
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Investor A (lump-sum investment) gets 3,000 units of the scheme for Rs 60,000 (NAV = Rs 20) Investor B (SIP investment) puts in Rs 5,000 each for six months.
Now, if the market rises for the first three months, then corrects for seven months and again recovers, this is a kind of situation both investors could find themselves in.
| SIPS LOSE LESS, TURNAROUND FASTER | ||||||||
| MONTH | NAV | ONE-TIME INVESTMENT | SYSTEMATIC INVESTMENT | |||||
| AMOUNT (Rs) | UNITS | VALUE (Rs) | AMOUNT (Rs) | UNITS | TOTAL (Rs) | VALUE (Rs) | ||
| 1 | 20.0 | 60,000 | 3,000 | 60,000 | 5,000 | 250.00 | 250.00 | 5,000 |
| 2 | 24.3 | 0 | 0 | 72,900 | 5,000 | 205.76 | 455.76 | 11,075 |
| 3 | 29.6 | 0 | 0 | 88,800 | 5,000 | 168.92 | 624.68 | 18,491 |
| 4 | 25.2 | 0 | 0 | 75,600 | 5,000 | 198.41 | 823.09 | 20,742 |
| 5 | 22.3 | 0 | 0 | 66,900 | 5,000 | 224.22 | 1,047.31 | 23,355 |
| 6 | 19.1 | 0 | 0 | 57,300 | 5,000 | 261.78 | 1,309.09 | 25,004 |
| 7 | 16.4 | 0 | 0 | 49,200 | 5,000 | 304.88 | 1,613.97 | 26,469 |
| 8 | 14.3 | 0 | 0 | 42,900 | 5,000 | 349.65 | 1,963.62 | 28,080 |
| 9 | 12.4 | 0 | 0 | 37,200 | 5,000 | 403.23 | 2,366.84 | 29,349 |
| 10 | 10.7 | 0 | 0 | 32,100 | 5,000 | 467.29 | 2,834.13 | 30,325 |
| 11 | 14.6 | 0 | 0 | 43,800 | 5,000 | 342.47 | 3,176.60 | 46,378 |
| 12 | 17.6 | 0 | 0 | 52,800 | 5,000 | 284.09 | 3,460.69 | 60,908 |
Investor A’s money will rise in the first three months from Rs 60,000 to Rs 88,800. In the following correction, his corpus goes down sharply to Rs 32,100 in the next seven months. That is, when the NAV in the tenth month stands at Rs 10.7.
Investor B, who is investing Rs 5,000 a month, gets only 250 units in the first month. After that, when the NAV starts rising, he gets 168.92 units at Rs 29.6 per unit, resulting in a total of 624.68 units. This will be valued at Rs 18,491 against the invested amount of Rs 15,000. The gain: A mere Rs 3,491. Investor A, on the other hand, is sitting on handsome returns of Rs 28,000 by now.
After this, when the NAVs start falling for the next six months, Investor B starts gaining in terms of units added. By the tenth month, when the NAVs are languishing at Rs 10.7, his investments are worth Rs 30,325 whereas he has only invested Rs 50,000. Investor A’s Rs 60,000 has become Rs 32,100.
However, as soon as the NAVs start improving from Rs 10.7 to Rs 17.6 in the last two months, Investor B is in the positive zone. His corpus is now worth Rs 60,908, a good Rs 8,000 more than Investor A’s. All this is simply because of more units. That is, Investor B has accumulated 3,460.69 units in one year, whereas Investor A is still stuck with 3,000 units initially purchased.
The lesson: SIPs may look slower in the short term and, especially, in a rising market. But over time, they give better returns.
The writer is a certified financial planner