Investing through SIP (Part 2)

Ramesh started his SIP in 2007.  He diligently invested every month a fixed amount and was happy with his fund performance.  Suddenly in early 2008, the market started tanking and he became concerned about his investments and discontinued his SIP.  He predicted market to fall further and decided not invest further till the fall is arrested.  He resumed investing in mid 2009 when the market started rising.

Ramesh, here, made a fundamental mistake in SIP investing.  As we discussed in the last article, SIP is for disciplined investing irrespective of the market movements.  By choosing not to invest during the downturn, Ramesh lost the opportunity to purchase (more) when the prices were low.  Had he continued investing throughout 2008 and 2009, his gains would have been considerably more than the present.

Read Part 1 of Investing through SIP

This brings to when SIP do not work.

1. As considered above, it does not work if you discontinue the SIP in the period of downturn.  You realize the main benefit of SIP only when you continue investing during the downturn.
2. SIP is not a correct way to invest if your horizon is short term.  The probability of markets being unidirectional i.e. either rising or declining is greater in short term.  You may lose value if you invest for short term in declining market and in rising markets your gains will be lower than if you had invested the entire sum initially.
3. It works for a portfolio of stocks and not on a single stock or few number of stocks.  Remember SIP is to be used only for investment in portfolio of stocks such as mutual funds.  It cannot work on a single stock.  You cannot choose a stock such as say TCS and start investing a fixed sum every month in the same stock.  The reason being volatility of a single stock is far greater than that of a portfolio of stocks and the returns from your investment may be significantly different from that of the stock.
4. SIP works to your advantage only for diversified equity funds.  You should avoid SIP for sector-specific funds.  This is quite obvious.  SIP is for long term investing and sector-specific funds basically focuses on short term favourites.  A particular sector (for eg: health care sector) may be in demand currently, but will not be after say 5 years from now.  Hence SIP does not work in sector-specific funds.  Again the volatility of sector-specific fund is higher than volatility of diversified equity funds.

Advantages of SIP

Many.  Important of them are:

1. Long term focussed disciplined investing. 
2. It never tries to time the market.
3. It buys more in declining markets and less in rising markets. 
4. Advantageous for those who have regular stream of income to invest.

How to invest in SIP

As for any investment, it is first important to identify the goal you want to achieve through SIP investment.  Based on the goal and time horizon, you should decide the asset allocation and identify the monthly investment amount required to achieve the above goal.   Next thing is to select a good diversified equity mutual fund scheme.  This you can select either from Mint 50 listing of mutual funds or from sites like Valueresearch.  Keep monitoring the performance of the scheme.  In case it is consistently different from that of benchmark, you should consider exiting from it and selecting a new scheme.  And last but not the least, ensure long term commitment and keep investing periodically.  Happy investing. :)

Comments and suggestions welcome.