What mutual fund SIPs are really about

They make you invest, automate that investment, and allow you to build wealth over the years

At around ₹5.65 lakh crore, systematic mutual fund investment plans (SIPs) account for 15% of total mutual fund assets under management (AUM).

This is higher than the 13% share in April 2021. SIP AUM grew at nearly double the rate of the entire AUM mutual fund between April and December 2021, with monthly SIP amounts exceeding ₹10,000 crore last September.

All of this is welcome! SIPs are great ways to invest and build wealth. But along the way, the SIP, its purpose and its benefits have become somewhat distorted. So here’s a perspective on SIPs – what they are and how they really help you.

Investments committed

In an SIP, you put money into a fund at regular intervals throughout the year. You already knew that. But what you’re probably also hoping for is the real benefit of this.

The biggest advantage of an SIP is that it guarantees that you are investing every month.

This ensures that you don’t overspend and skimp on savings. This does not give you the excuse to postpone your investments to the next month. For employees in particular, with income that comes in every month, SIPs are the best way to ensure that investments are made.

Plus, by investing smaller amounts each month, SIPs allow you to build wealth slowly and surely.

Big financial goals are hard to achieve with lump sum investments for most of us! As your income grows, increasing your SIP amounts – and AMCs and investment platforms offer several convenient ways to increase SIP amounts – will improve your wealth building and ensure that the savings follow the increase in income.

Not a cure

But the emphasis on SIPs in recent years has reduced this fundamental advantage and elevated others, giving SIPs an often misunderstood identity.

Let’s take advantage of the “average cost in rupees”. In reality, averaging costs down is not easy. To truly reduce average costs, two factors are necessary. First, markets should correct. Second, you need the market fall to continue long enough (or to be steep) to be able to create enough additional SIPs at these lows, so that your overall investment costs go down.

When you execute SIPs during a market rally, your costs actually increase as you invest at higher and higher levels. The longer the rally, the more your costs tend to rise and the more you need a correction to reduce costs.

The longer you run your SIP, the longer you need a long downturn in the market to average, as your investment amount itself is likely to be large.

Next, consider the advantage that SIPs are the solution to investing at the wrong time. Yes, SIPs help reduce the risk of investing at highs when stocks hit highs, as SIPs allow investing at different NAVs and market levels. But this is often distorted by the belief that SIPs prevent losses or guarantee high returns. It doesn’t happen.

SIPs are a form of investment. You are not investing in a SIP. You invest in a fund through an SIP. Your investment is the fund. Your return will be that of the fund. If a fund is unable to perform well, having invested through the SIP will not improve that performance. If the markets correct, so does your fund and your investment.

To expand this point further, you also don’t have “SIP funds” or “lump funds” for the same reason. SIPs and lump sums are only methods of investing in a fund and do not constitute the investment itself. You only have good funds that are worth investing in, whether through SIP or lump sum.

With stock markets in crisis for almost two years now, and without a prolonged period of correction even before that, it’s important not to lose sight of what SIPs are and aren’t. Having high or wrong expectations of your SIP could disappoint you and cause you to lose confidence in your investments if the markets resume a pause this year.

This can cause you to stop SIPs, the one thing you shouldn’t do. You need to run your SIPs through a market correction to really get their “average” effects.

Not always necessary

The risk of bad timing and the advantage of the average are also applied evenly across all funds, making SIPs the only or the right way to invest. No. Again, look at what SIPs do.

SIPs reduce high investment risk. But this high risk of inappropriate investments mainly concerns equity funds (and aggressive hybrid funds). Only stock markets can fall sharply or stay down for a long time. The risk of bad timing is minimal or very short-lived in all debt funds (other than gilt funds) and in hybrid categories other than aggressive hybrids.

Likewise, only in aggressive equity/hybrid funds can you take advantage of market volatility, investing on the dips and cutting costs. In the absence of this volatility, you get no average advantage; in such funds, as long as your timing is correct, it does not matter whether you invest via SIP or lump sum.

Therefore, remember the fundamental benefit and need of an SIP, which is that it makes you invest, automates that investment, and allows you to build wealth over time. Don’t focus too much on other aspects that may not apply and may only confuse or disappoint you.

(The author is co-founder Primeinvestor.in)

Dolores W. Simon