How SIPs Work

You may have heard this from almost every relationship manager, wealth manager, mutual fund agents, etc that the best way to invest in these volatile times is via SIPs. I have come across a couple who couldn’t even let me know the full form of SIP but were very well chanting upon the benefits of SIP and the glorious investment methodology it follows. Some white collar advisors used complicated terminologies to sound SIPs as one of the best investment tool invented by them. However, what exactly is SIP?

What is SIP?

SIP stands for Systematic Investment Plan. As the full form entails, it requires a person to be systematically investing into any asset product, such as equity, gold, debt, fixed deposits or even land. However, it has been more commonly used for investing towards investing into Mutual Funds. SIP requires a person to invest on a regular basis (can be monthly, quarterly or half yearly) into a mutual fund and hence enforcing a disciplined approach towards investing. Hence you may note that it is not a rocket science. It just forces a person to be disciplined and be regular with their investment, a thing which is most commonly ignored.
The oldest and most common form of investing via SIP has been investing into LIC / Insurance policies which required a person to pay yearly insurance premium for several years and after that reap the maturity proceeds. However, the disadvantage of investing into LIC / Insurance policies were lack of flexibility to discontinue the payment of insurance premiums and hence a person was forced to invest regularly for several years (10-20 years) till maturity. Another commonly heard product is Recurring Fixed Deposits or RDs where a person makes a regular investment with a bank or a post office and gets the lumpsom amount with interest at maturity.

So what exactly SIP achieves ?

Month	Monthly Investment	Gold price	Grams Purchased	Total Grams Purchased	Total Investment	Cost Per Gm	Value of Gold	Profit / Loss
A	B	C	D	E	F	G	H	I
1	10,000	5,000	2.00	2.00	10,000	5,000	10,000	-
2	10,000	5,200	1.92	3.92	20,000	5,098	20,400	400
3	10,000	4,800	2.08	6.01	30,000	4,995	28,831	- 1,169
4	10,000	4,750	2.11	8.11	40,000	4,931	38,530	- 1,470
5	10,000	4,500	2.22	10.33	50,000	4,838	46,503	- 3,497
6	10,000	4,600	2.17	12.51	60,000	4,797	57,536	– 2,464
7	10,000	4,800	2.08	14.59	70,000	4,797	70,037	37
8	10,000	5,150	1.94	16.53	80,000	4,839	85,144	5,144
9	10,000	5,250	1.90	18.44	90,000	4,881	96,798	6,798
10	10,000	5,200	1.92	20.36	100,000	4,911	105,876	5,876
11	10,000	5,300	1.89	22.25	110,000	4,944	117,912	7,912
12	10,000	5,450	1.83	24.08	120,000	4,983	131,249	11,249

The prices are hypothetical to explain the concept of SIP in Gold.
To explain the above table, if you invested a monthly amount of Rs. 10,000 over a period of 12 months, you would have invested a total of Rs. 120,000. Each month, at the prevailing rate of Gold (in our example, Rs. 5,000 / gm, Rs. 5,200/ gm and so on), a specific grams of gold would be purchased (Column D). Hence, due to monthly fluctuations in the price of gold, you would purchase different grams of gold for the same Rs. 10,000 investment amount. Over a period of 12 months, you would have purchased a cumulative 24.08 grams of gold which at the closing price of 12th month would be valued at Rs. 131, 249. You would be gaining Rs. 11,249 over your intial investment of Rs. 1,20,000. You may notice that while during the course of 12 months, for months 3 to 6, you would be having notional losses, however owing to the consistent investment approach, you would be averaging down the cost of your gold (per gram). Since over a long term, gold prices would be heading north, you would stand to gain from the gold purchased at lower prices.

If SIPs are that simple, why don’t every one become rich ?
This is an excellent question with a very simple response. There is a common saying while investing into stock markets – When every one is greedy, be fearful and when every one is fearful, be greedy. What it means is that when every one is very bullish about the stock markets, it is a time to become conservative and vice-versa. However, even after knowing this time tested theory, people tend to doubt its relevance when there is blood on the stock markets. In these testing times, every one tries to seek for shelter in fixed income products such as fixed deposits which would provide a specific return for your money and would keep your capital safe. However, the thing which gets forgotten is that fixed deposits would keep the capital safe, but won’t provide growth to the capital.
Hence in testing times, people loose their patience, stop buying into the stock markets or rather sell their existing stock / mutual fund holdings and thus loose their opportunity to enhance their long term returns.

So how should I proceed with SIP ?

The following steps may be followed to be a successful investor in SIP:
1. The first and foremost, contact your financial advisor to arrive at an amount which you should invest into SIPs. Avoid contacting mutual fund agents who may find it lucrative for you to invest as much as possible into the SIPs as it would provide them more commission income. The SIP amount should be selected based upon your monthly savings and long, mid & short term liabilities. A too large SIP amount would make it very difficult for you to meet the monthly commitment, eventually force you to stop your monthly SIPs and hence defeating the overall purpose. On the contrary, a too small SIP amount won’t achieve your future goals. It is very possible for initial investors to invest too little as they don’t understand the product and hence reduce their future growth opportunities;
2. Select a right mutual fund scheme to invest your SIPs into. The schemes should be intelligently selected to provide you a good combination of diversified, sector specific (such as Banking, Infrastructure), asset specific (such as Gold) and market capitalisation (such as Large cap, mid cap and small cap stocks) exposure. A right scheme would go a long way in enhancing your returns in future.
3. Make sure that you fund your bank account regularly to avoid your SIPs from bouncing. This is the simplest and the most ignored aspect. Generally the bank balance from where the SIPs are deducted reach a zero and the investor forgets to replenish the bank account for the funds required for SIP. Either you or your financial advisor should monitor your SIPs to ensure that they don’t bounce due to this issue.

Advantages of SIP

One of the biggest advantage of SIP is its simplicity and flexibility. To enumerate them in a bit more detail, the advantages are:
1. SIPs in mutual fund can start with an amount as little as Rs. 500. Hence you don’t need to have a big bank balance to start your investments.
2. You can at any time increase your monthly SIP amount, reduce it or stop it. For example, you can initially start with a SIP of Rs. 5,000 per month and when your financial cash flows improve, you can increase it to Rs. 15,000 per month. If your financial cash flows deteriorate , you can reduce the SIP amount to Rs. 7500 per month.
3. You can encash your SIPs at any time and hence it provides a high level of liquidity to your investment. While being a big advantage, this acts as a biggest risk to your future savings as well as it would not prevent a person from using it as a regular source of funding for their short term expenses.
4. SIPs in equity mutual funds is tax efficient. As per the current tax laws, entire capital gain on Equity mutual fund SIPs is tax free. For example, if you invested Rs. 10 lacs over a period of 10 years and it is valued after 10 years at Rs. 1 crore, the entire capital gain is tax free as per the current laws.
5. Slowly and steadily, SIPs help you in saving a considerable amount of funds for your long term requirements. Since they are done on a monthly basis, it inculcates a disciplined approach towards investments and gets incorporated in your monthly budget.

What is SIP?

So what exactly SIP achieves ?

To explain this question, lets take one asset class which most of you would be most comfortable with (specially ladies) – GOLD. It has been passed on from generations that Gold as an investment asset class is one of the least risky or rather risk free investment. If we look into past 10 years, gold has been increasing from around Rs. 5000 per 10 gram to around Rs. 25,000 per 10 gram which around 5 times over the period of 10 years. Not that I am suggesting that this kind of growth would continue in future, however there were times where the gold prices didn’t move at all, rather they experienced a negative return. Only the investors who invested with a long term outlook would have benefited the most out of this bull run of gold prices.

If SIPs are that simple, why don’t every one become rich ?
This is an excellent question with a very simple response. There is a common saying while investing into stock markets – When every one is greedy, be fearful and when every one is fearful, be greedy. What it means is that when every one is very bullish about the stock markets, it is a time to become conservative and vice-versa. However, even after knowing this time tested theory, people tend to doubt its relevance when there is blood on the stock markets. In these testing times, every one tries to seek for shelter in fixed income products such as fixed deposits which would provide a specific return for your money and would keep your capital safe. However, the thing which gets forgotten is that fixed deposits would keep the capital safe, but won’t provide growth to the capital.
Hence in testing times, people loose their patience, stop buying into the stock markets or rather sell their existing stock / mutual fund holdings and thus loose their opportunity to enhance their long term returns.

So how should I proceed with SIP ?

Advantages of SIP

One of the biggest advantage of SIP is its simplicity and flexibility. To enumerate them in a bit more detail, the advantages are:
1. SIPs in mutual fund can start with an amount as little as Rs. 500. Hence you don’t need to have a big bank balance to start your investments.

2. You can at any time increase your monthly SIP amount, reduce it or stop it. For example, you can initially start with a SIP of Rs. 5,000 per month and when your financial cash flows improve, you can increase it to Rs. 15,000 per month. If your financial cash flows deteriorate , you can reduce the SIP amount to Rs. 7500 per month.

3. You can encash your SIPs at any time and hence it provides a high level of liquidity to your investment. While being a big advantage, this acts as a biggest risk to your future savings as well as it would not prevent a person from using it as a regular source of funding for their short term expenses.

4. SIPs in equity mutual funds is tax efficient. As per the current tax laws, entire capital gain on Equity mutual fund SIPs is tax free. For example, if you invested Rs. 10 lacs over a period of 10 years and it is valued after 10 years at Rs. 1 crore, the entire capital gain is tax free as per the current laws.

5. Slowly and steadily, SIPs help you in saving a considerable amount of funds for your long term requirements. Since they are done on a monthly basis, it inculcates a disciplined approach towards investments and gets incorporated in your monthly budget.

Understanding Mutual Fund With a different perspective

On friendship day, one of our friends asked us “you keep talking about investment to people, why don’t you tell me some good investment” . We said that you should look at regularly investing in Mutual Funds through Systematic Investment Plan(SIP). But the moment we said Mutual Fund, He replied ” I have heard that Mutual Funds are not safe and it is better to invest in policies of LIC or other insurance companies. They offer better return as well.”

Now this is something which is very common to hear. Many investors have not yet understood that in fact mostly all the investment that you make today are mutual funds (collective investment scheme )only. Now whether you invest in LIC’s Future plus or HDFC Standard life’s Youngster Plan or ICICI’s unit linked plan or you buy New Pension scheme by government or any of the endowment plans, they all are nothing but mutual fund based investments.

To understand it in better manner,we need to understand how your savings are channelized in economic activity.

From the time we got independence in 1947 and till late 80′s the economic activity was mainly driven by government.It was government who build the road, set up power plants, started schools, build hospitals and what not . So they were in need of money to finance all these activities. It was government who needed to borrow the money and since government has the power to print the money, all the schemes through which they used to borrow, they all were GUARANTEED RETURN products.

But later on since early 90′s when our economic was opened up, the private sector took the lead and majority of our economic activity are now in the hand of private sector. Government has become more of a regulator. Now roads are built by private companies and we all pay toll charges. Not many would go to government hospitals or government school. Power is generated by Reliance Power, Tata Power etc. Now private sector needs finance to run the show.

But the point is that they cannot print money if they incur losses but government could do that. So your saving are now given to private sector and government is not much interested as they are able to meet their expense by way of tax collection.

In fact, just to emphasis that government is not interested in borrowing your money we would like to give couple of complete examples.

Earlier, there used to be a SMALL SAVINGS DEPARTMENT in all the districts of Rajasthan and agents were given heavy commission to collect the money. Many of you would remember those CHANDI KE SIKKE which investor used to get from agent if you invest in NSC ( National Savings Certificate). Sometime back, all the district level division were closed and now there are only two officers handling Small Savings Agency in Jaipur.

Earlier, most of the policies of LIC used to be GUARANTEED RETURN Policies as government used to borrow from LIC and since government gave guarantee, in turn LIC gave you guarantee. Now LIC has also stopped giving Guarantee in almost all the policy that they run.

Basically the government is now concentrating more on revenue based inflows like income tax, service tax etc rather than borrowing based inflows like PPF, Post Office etc.

Now, coming to our main discussion, when your saving goes to private hands, return cannot be GUARANTEED. Now we need a help of specialist who would guide a common investor to whom should he lend, where should he invest. Now here comes to role of mutual fund where you have a specialist who guides you where to invest your money and since there is no guarantee, the investment value is based on market valuation which is nothing but NAVs.

So whether you invest directly through mutual funds or through Insurance based products, you are buying market-linked investment only. But our friend thinks that Insurance policies offer better return. Why does he think so?

The reason behind is the Mis- Selling tactics used by agents and insurance companies. Since insurance is by law a long term product, it is easy for agent to mis-guide investors at the time of sales as they know that the investor will only come to know after so many years and till that time, they would have earned their heavy commissions. WHO CARES.

But when it comes to someone who distributes or sells you Mutual Fund directly, one That he hardly get any commission form the mutual fund company at the time of sales; secondly he knows that mutual funds can be withdrawn at anytime and are very transparent, they cannot mis-guide people by showing that they will get high returns. A mutual fund distributor will only say that you will get returns based on market.

1. Almost all the products are now market- linked and products which still offer GUARANTEE are most unsuitable for long term wealth creation as they cannot beat inflation and are most tax- unfriendly.

2. Mutual Fund investment is now everywhere, whether you take Mutual Funds directly or go through indirect way of mutual fund investment which is insurance companies. Its better that you understand Mutual Funds as soon as possible. In fact, post 2004, whosoever who is joining government sector is putting his compulsory retirement contribution to NEW PENSION SCHEME which is nothing but mutual Fund. What they will get at the time of retirement will be determined by market and government is not guaranteeing anything.

Direct investments to Mutual Funds are simple to understand and offer much needed transparency. After all these discussion, we still left the last decision with our friend; eventually, it is his money and it is his choice. we can only give our recommendation!

Pages

Thursday, 17 May 2012

PREDICTIONS ARE INJURIOUS TO WEALTH

Saturday, 12 May 2012

How SIPs Work

How SIPs Work

Wednesday, 9 May 2012

Understanding Mutual Fund With a different perspective

1. Almost all the products are now market- linked and products which still offer GUARANTEE are most unsuitable for long term wealth creation as they cannot beat inflation and are most tax- unfriendly.

Direct investments to Mutual Funds are simple to understand and offer much needed transparency. After all these discussion, we still left the last decision with our friend; eventually, it is his money and it is his choice. we can only give our recommendation!