Mutual funds? Myths surrounding SIPs

What is a Systematic Investment Plan (SIP)?

An SIP is simply; a method of investing a fixed sum, regularly, in a mutual fund. It is very similar to regular saving schemes like a recurring deposit. An SIP allows you to buy units on a given date each month, so you can implement an investment / saving plan for yourself. Once you have decided on the amount you want to invest every month and the mutual fund scheme in which you want to invest, you can either give post-dated cheques or ECS instruction, and the investment will be made regularly.

As is customary I have I have started with describing what an SIP is. Let us break some myths on SIP.

1. Investment in equity mutual funds or unit linked insurance should ALWAYS be done in SIP mode: I remember in 1999 when Templeton Mutual fund talked about SIP – the market looked at it skeptically. And it would take a lot of convincing for customers to accept it. Now, life has come a full circle. Everybody wants to (ALWAYS) invest using SIP. If you have the maturity and calmness to realize that equities are for the long term and are willing to give your funds about 10 years, AND you have a lump-sum, you can afford to give the SIP route a go by. However if your horizon is less than 5 years, you MUST do an SIP.

2. I do rupee cost averaging in a single equity – that is a kind of SIP is it not? This is a question I face every day. NO a rupee cost averaging in single scrip cannot be equated to an SIP. When the market brings down the price of single scrip it is giving you information. You need to react to that. Let us take 2 examples – Lupin laboratories – has moved from a high of Rs. 700 to Rs. 100 and back to Rs. 700. The question to ask is not whether SIP would have worked. The question to ask is whether you would have had the stomach to continue the SIP through the period. Silverline technologies moved from 30 to 1300 to 7! If you had started the SIP at a price of Rs. 1300 – today you would be licking your wounds. SIP works in a portfolio, not in single scrip.

3. You CANNOT invest a lump-sum in the same account in which you are doing an SIP. I have no idea why this myth has got into people’s head. Many people think if they are doing an SIP in a particular fund, and suddenly they have a surplus, they cannot put that lump sum in that account – far from it. In case you are doing a sip of Rs. 10,000 per month in equity fund, and suddenly you have a surplus of Rs. 100,000 and clearly you have a 10 year view on the same, just push it into your SIP account. SIP is just a payment mode, not a scheme!

4. If I miss investing for a particular month, will they prosecute me? This is the EMI fear that people have. In an SIP you are buying an investment every month (or quarter) – there is no question of prosecuting you for not missing one investment. As a matter of discipline, you should not miss any month; however, missing one month’s investment is not a crime!

5. When you have a surplus (accumulation stage of your life) you should do an SIP and during retirement you should do a SWP! No. you should keep your withdrawals only from an income fund or a bank fixed deposit. You should sell an equity fund on some other basis – say deciding to sell 20% of your portfolio in a year that the return is 4 times the 30 year historic return. SWP, by definition cannot work in an equity fund!

6. SIP works for everybody, but does not work for me! Another myth. SIP works in a well diversified equity fund in the long run. When people put forth arguments that it does not work for them, they have either not chosen a good fund or are looking at a 12 month horizon.

7. SIP is only for small investors. Nothing can be farther from the truth. I have a client who has invested Rs. 42.66 lakhs using SIP – starting from Jan 1998 till date. Obviously he has invested much more in later years as his income went up – and the funds together are worth Rs. 127 lakhs – substantially higher than his provident fund.

8. Market is too high to start an SIP – I have heard this when the index was 3000 also. I have no clue where is the market headed, but I know SIP works!

9. All fund houses are now charging a full load on the SIP, so now SIP will not work. Why not time the market? Introducing an entry load was expected to happen and it has happened. What actually hurts the retail investor is the asset management charges – 2.5% in most cases is a bigger threat to compounding!

10. If a do an SIP in a tax plan, can I withdraw ALL the money on completion of 3 years? Another regular question almost all day! The answer is every instalment has to be with the fund house for 3 years. The lock-in comes from the Income tax rules which say that a tax saving scheme should have a 3 year lock-in.

You cannot escape that by doing an SIP!

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4 Responses to “Mutual funds? Myths surrounding SIPs”

  1. “However if your horizon is less than 5 years, you MUST do an SIP.”

    Height of stupidity! Go Read Benjamin Graham – the father of value investing – write about dollar cost averaging (today’s SIP) in 1949. The logic behind this investment plan is that you should buy more in a bear market, and less in a bull market – that is not get carried away in a bull market, and not to remain in the sidelines in a bear market. The implication is that you should have the conviction for equities or the portfolio (the fund that you are investing). Since the investment cycle is AT LEAST one bull cycle + one bear cycle, it would be greater than 10 years. And, Ben Graham & Warren Buffet are famous to take a minimum 30 year view. It’s simply ridiculous to suggest that SIP works for less than 5 years.

  2. aa whats your take? SIP works, does not work, can never work, …..? and what is the implication of that for a common man. If there is a conflict between Buffets writing and John Templeton’s writing, by the way, what should one do?

  3. paramjit singh on June 3rd, 2008 at 3:29 pm

    aa i do not know what is stands for and I do not want to guess. Please take a stand and say that SIP does not work for 5 years – and then we can argue. If you say that equity works ONLY in 30 year kind of time frames, God save the brokers. If you say we should all be investing with a 30 year time frame, I am doomed. I am 38 years old and age 68 surely my son-in-law will look at my portfolio and say “No pop in law you got it all wrong” and then go an spend all my money! (BTW my daughter is 9 years old)

  4. aa’s comment seems to be funny. Yes of course equity is for the long run, so what to do? I think if SIP is a good way of investing it is good for both long run and short run is it not? SIP of mine which is 3 years old is currently out of money! I think by just continuing to do the SIPs one can improve the returns. If Aa is saying that only people with 20-30 years horizon should invest in equity shares (he may be right) he is talking to the wrong audience perhaps.

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