Due Diligence. When to skip the SIPs

The glories of investing a small sum every month are many. Systematic investment plans (SIP), which allow you to invest in fixed periodic instalments, help inculcate a savings habit. SIPs help get around the problem of timing the markets too. But the SIP is not a tool that can be wielded in all investments. Sometimes, an SIP strategy may not work to your advantage.

On the surface, using SIPs to buy individual stocks may address the question of when to time market entry. But then, the risk you are taking on is materially pushed up.

First, stock SIPs steadily build concentration to a particular stock (or even set of stocks). An SIP of ₹5,000 run for five years totals ₹300,000 — a huge exposure for a few stocks.

Concentration worries are far lower in a diversified mutual fund as funds hold a basket of stocks — they often have over 40 stocks in their portfolio. Stocks held also change depending on market movements. Rules also don’t allow funds to go beyond 10 per cent in exposure to a single stock.

Second, a lot hinges on your ability to pick a winning stock. Should your stock fall out of favour, you would be increasingly throwing good money after bad. Investing at one go would have automatically involved a lower exposure to that stock. Even running SIPs over the long term in stocks won’t help if the stock is trending down.

Let’s say you restricted yourself to blue-chips only, as they involve the least risk. You started buying one stock each month starting from January 2009. Considering the Nifty basket, if you had been prescient enough, you may have picked HCL Technologies or Sun Pharma or Lupin and sitting pretty on overall returns of over 40 per cent.

But if you had instead bet on Jindal Steel or NTPC or DLF, you may be suffering losses.

Picking a mutual fund is easier; there is a track record to judge its ability to consistently manage returns well.

SIPs also predominantly don’t work when you are looking to invest for a short term. Market cycles usually last for about a year or two, except for maybe the 2003 to 2008 bull market. So, for an SIP in an equity fund to work, they must be run over a long period of at least four to five years.

An SIP maintained for just a couple of years in a bull market would have you averaging your costs upwards. It would not give the opportunity to buy units when markets are sliding, helping you lower your overall costs.

For instance, take the past two years, when markets were mostly rising. Say you started an SIP in HDFC Top 200 from January 2012, continued it for just 12 months and then pulled your money out. A lump sum investment in January 2012 rally would have given a 34 per cent return by January 2013, against the 27 per cent an SIP run for the duration would have delivered.

If the SIP had begun five years ago instead and continued to date, SIP returns would stand at 19 per cent. Compounded annual returns for a lump sum investment for the same time period would be 11 per cent. Similarly, maintaining an SIP only in a falling interest rate scenario may result in more units bought at higher and higher prices. An SIP won’t work for a short-duration debt fund either.

Therefore, for goals of one to two years, an SIP is not advisable for both debt and equity.

Using SIPs in sector-themed funds is not advisable either. For one, all themes go through cycles. If it was infrastructure and metals in the heydays of 2007, it has been consumer goods, pharmaceuticals, and software in the past couple of years.

Two, it’s hard to judge when sector shifts occur in markets. Three, investing in a theme while it is in play will simply result in you averaging costs higher, as explained earlier.

So, if an in-theme looks good at the outset and an SIP is begun, it can peter out quickly. Even if you are buying more and more units at lower costs when the theme is down, that theme may not be picked up again for a long time, as is the case of infrastructure funds. All you will be sitting on are losses or low returns.

Themed funds, by their very nature, require you to time your entry and exit.