How To Create Wealth From Your SIP's

Mutual Fund Systematic Investment Plans (SIP's) are all the rage right now. Advisors and Asset Management Companies alike are espousing the benefits of making 'bite sized' monthly investments into the stock markets via SIP's, rather than making lump sum investments and diving in with both feet. According to informal estimates, the industry is adding close to 1 Lac new SIP's every month, net of stoppages.

For the vast majority of retail investors, SIP's represent the proverbial 'promised land' - an investment avenue that not only results in the mitigation of risk over the long term, but one that also has the real potential to grow your savings at a faster rate than inflation. Throw in tax efficiency, and you have an investment avenue that's nearly twice as good as other alternative tools to channelize long term savings in a systematic manner. For instance - UTI Midcap Fund delivered a compounded annualized SIP return of 26.44 per cent in the 5 years between June 2011 and June 2016 (which essentially means that a monthly investment of Rs. 10,000 would have ballooned to over Rs. 11 Lacs in this period). And yet, it's a terribly irony that the vast majority of Mutual Fund investors will, in fact, not be reaping the long term benefits of SIP's. Thousands of well-intentioned investors stop their SIP's every month - goaded either by the need for cash to fulfill short term needs, by impatience, or by irrational fears about the future of the stock markets.

If you'd like to avoid a few common traps associated with SIP investing and go the full distance to the achievement of your long term Financial Goals, here are a few things for you to keep in mind.

Trying to time the market will work against you
An interesting study by Charles Schwab Institute of Financial Research proved that investors who 'perfectly timed' the market with lump sum investments only marginally outperformed investors who invested their money immediately and held on for 20 years. However, not many investors actually have the stomach to be so bold and decisive - most investors will prefer to delay their investment in order to 'achieve better timing'. This is probably the worst approach of all, as it might lead to extended periods of sitting in cash investments (and if you're unlucky, to really poor market timing)

Investing fixed amounts of money every month through SIP's makes for a fitting middle ground between investing everything at once, and perennial procrastination. However, trying to time the market with a SIP investment defeats its core purpose. SIP's are designed to help you avoid procrastination, minimize regret and avoid market timing strategies (which very rarely succeed). Going back to our previous example of a SIP in UTI Midcap Fund - a monthly SIP of Rs. 10,000 started in January 2008 (before the markets went into panic mode and collapsed) would have grown to Rs. 26.42 Lacs by June 2016 - a compounded annual growth rate of nearly 22 per cent. And this, in spite of the NAV falling from close to Rs. 35 in January 2008 to as low as Rs. 12 in March 2009. Imagine the plight of the hapless market timer amidst all this chaos!

R Raja, Head - Products, UTI AMC drives this point home. "It is very difficult to get the timing right. In most of the cases, the time in the market is more important than timing. An investor could invest systematically invest across all assets say a mutual fund investing in equities, debt, balanced fund or an asset allocation fund to moderate the volatility and lend stability to returns" he says.

You've got to ride out the bad times to reap rewards in the good times
Sometimes, SIP investments go through extended phases of low or even negative returns. A case in point is the past 12 months leading up to June 2016, where the SIP returns from even the most high performing equity schemes would have ranged from 5-7 per cent. Similarly - those who invested Rs. 10,000 per month in SIP's between April 2008 and March 2009 would have likely seen their fund values eroded to Rs. 90,000 or less (annualized returns of over -50 per cent).

Raja of UTI AMC urges investors to stay put. "Be patient -good things come in spurts-usually when least expected. If you missed those few and fabulous periods, you would have missed all the total returns accumulated over three full generations", he advises.

There are two things a SIP investor needs to understand. Firstly, SIP's are a long term wealth creation tool. They work best when allowed to run dispassionately across multiple market cycles, because markets are rarely (if ever) rational and eventually, the principle of mean reversion will kick in and drag down euphoric markets or invigorate even the most trampled indices. Secondly, it is the low return phases (probably a cumulative 3-5 years in a 20 year SIP lifecycle) that provide the highest unit accumulation potential. Riding out these phases and shutting yourself out forcefully will hold you in good stead - getting impatient and comparing your SIP investments with fixed return instruments will deprive you of most of the value creation you could have potentially achieved.

Raja accepts that this is easier said than done. "For most investors, the hardest part is not figuring out the optimal investment policy, it is staying committed to sound investment policy through bull and bearish markets and maintaining 'constancy to purpose'. Sustaining a long-term focus at market highs or market lows is notoriously difficult", he says.

Align your SIP's to clearly defined Financial Goals
Aligning your SIP's to tangible, clearly defined future goals will go a long way in helping you create wealth from them. Your goal must have a clear timeline, a future value, and most importantly, be significant enough for you to want to save for it.

You'll be surprised to know that Goal based SIP investing automatically mitigates most of the associated pitfalls. The focus automatically shifts from absolute returns to long term accrual, and the desire to constantly tweak is replaced by the desire to see your goal based corpus accelerate over time. You'll probably be more serious about allowing your SIP's to be debited in a disciplined manner, which optimizes the associated Rupee Cost Averaging benefit.

Here's a quick pointer - go beyond just planning for your goals as a onetime activity. Use tools, and the support of a Financial Planner, to periodically monitor your goal progress. "Own" your goals!

Don't change your SIP's frequently
If your SIP's are in relative outperformers with long term track records, you would be ill advised to change your SIP's frequently to keep up with last quarter's performers. Over the long run, the relative outperformance you are aiming to achieve by being invested in the 'flavor of the season' Mutual Fund will most likely not materialize.

The reasons for this phenomenon are twofold. Firstly, your decision to stop your SIP in one fund and start in another will in all likelihood be driven by a comparison of past returns - which means you'll be reducing your exposure to a fund which is quite possibly at a takeoff point and increasing your exposure to a fund which has already gone through an upcycle . Secondly, in the long run, there's very little to separate the SIP returns of top performing funds. Starting and stopping will invariably be accompanied with the human tendency to overanalyze the situation and time entries and exits precisely, and this will impact the long term growth of your portfolio.

Beware of the 'hyperbolic discounting' trap
Hyperbolic discounting refers to the tendency for people to increasingly choose a "smaller-sooner" reward over a "larger-later" reward as the delay occurs sooner rather than later in time.

As your SIP's lead to the accumulation of a corpus that is sizeable, you'll surely be tempted to liquidate them to fund other "smaller-sooner" needs. For instance; the newest gadget, a new car or a vacation might suddenly seem more important than your Child's higher studies or your own Retirement.

SIP investors are advised to exercise caution in this regard and stay focused on their long term Financial Planning objectives. Doing so will not just stretch the time horizon of their investments, but eventually lead to the satisfaction of having used their hard earned money to fulfill more significant goals. Your new iPhone will become redundant in a year, but your Child's MBA degree will create value for her for a lifetime.

Turtles can fly - but only if you wait long enough
If the investment universe were re-written as the Jungle Book, SIP's would be "Oo the Turtle" - but with the magical ability to develop a pair of wings after ten years, and a turbocharged engine after twenty.

SIP's work on the principle of compounding - that is 'growth on growth'. Running your SIP for three years will not serve much of a purpose - but running them for ten years surely will. Similarly, your SIP investment portfolio will likely double in the five years from years 25 to 30. "Equities outperform other assets over a long period of time and if the markets have not done well during certain periods of time, there is need to wait patiently for the markets to deliver returns", Raja advises us in this regard.

The moral of the story is that the best time to stop and redeem your SIP is as late as you can afford to. If you can keep them running through thick and thin until the day you retire, do so. If you've just had a new born child and have 18 years to go until her higher studies, plan a SIP right away. Time is fuel for your SIP's, so don't clip the wings of a potential wealth creator by redeeming early.