Last week, I got many calls asking whether they can stop their SIPs because of the crash in the market. I thought of answering this by giving the live example of a major crash in 2007 and the subsequent recovery in the market. Before going into the actual case study, let us understand what a SIP is?
What is Systematic Investment Plan (SIP)?
All of us know what a Recurring Deposit (RD) with a bank is. It is nothing but investing a predetermined amount every month in a bank for a particular period. SIP is exactly the same in mutual funds. Systematic Investment Plan (SIP) is investing a fixed amount regularly, without looking at the level of the stock market. If the markets are high, you will get lesser units and if the markets are low, you will get more units. This will average out your cost per unit and will benefit in the long term, when the market rise. This is called Rupee cost averaging and has proved very useful to investors. Now we have monthly, fortnightly and even daily SIP to suit customer’s needs. You can start SIP with even Rs.500/- per month.
Advantages of SIP?
1. It encourages disciplined savings and benefit by the power of compounding:
First of all, SIP is a tool where, you are putting your regular savings into regular investment. It makes sure that you don’t over-spend if the money would lie idle in your account. It also works on the principle of Power of Compounding as the moment you save, you are investing immediately and hence you give maximum time to your investment. World over it is accepted as the most efficient method for wealth creation.
Let us take the example of 2 friends A and B who started their career at age 25. A started an SIP of Rs.5000/- immediately while B decided to start savings from the age of 35. He decided to save monthly Rs. 10,000/-. Who will have more money at the age of 55?
Total investment of A in these 30 years is 18 Lakhs, while B invested 24 Lakhs in 20 years. But at an assumed annual return of 12%, A will have 1.74 Crores and B will have only 99 Lakhs in his account. This is the power of compounding. If you start early savings, you can reach your goals with less monthly commitment.
2. It is easy to start, flexible and liquid.
SIP is easy to start. You have to just give cheque for one month and from next month, you can opt for direct debit from your bank account. You have the flexibility to withdraw for any emergency or even stop.
Best Funds for SIPs
We give below some of the top performing funds, which you can select for SIPs. You can see that the SIP method of investment has created higher returns than the Lump sum investment for the same period. The period covered here is from December.2007 to December.2010, which includes the major crash and the recovery in the stock market.
|Fund Name||SIP returns from
Dec. 2007 to Dec.2010
|Annualized return from Dec. 2007 to Dec. 2010 for a lump sum investment made in Dec. 2007|
|HDFC Top. 200||32.04||12.17|
|Birla Sunlife Frontline Equity||27.63||7.86|
|DSP BR Top. 100 Equity||24.13||6.69|
How, you benefit in a volatile stock market?
In a volatile market, it is always advisable to invest by way of SIP, because, it will average out your cost. You will get more units when the markets are down and fewer units when the markets are up. Please note in the above chart the returns through SIP investments are around 29% while the return through lump sum payment was only 9.5%. Now look at the Sensex values during the same period.
Sensex was at 20286 at the end of December. 2007 and had a major crash in the following period. By June 2008, it was down at 13462 and reached the low of 9647 by Dec. 2008. Then it started the upward journey with many ups and downs in between and finally reached 20509 in Dec. 2010. If you compare the gain in Sensex between this 3 year period, it is practically NIL. But what about the returns for the mutual fund investors during this period?
It is clear from the first chart that the SIP investors in the suggested 5 funds made an average return of 29% during this period on their investment, while those invested in lump sum in Dec. 2007 also made around 9.5% returns, in a market which has not really grown on absolute terms. This is the power of SIP investments. When the market was going down from 20,000 levels to 9600 levels, lot of investors stopped their SIPs, and they were lost out from these gains.
The golden lesson is volatile market is the ideal time to reap more gains for SIP investors. Don’t stop the SIPs when you see markets are crashing. If you can afford, start more SIPs in situations like this. This is because, you will be the winner, when the markets bounce back.
If you want to make money in the stock market, you must invest when others are selling!