By Sunil K Parameswaran
Systematic Investment Plans or SIPs are often prescribed as an ideal solution for building a corpus. These plans require one to put aside a sum of money at periodic intervals and invest the savings in a mutual fund or a portfolio of mutual funds. This is a blind strategy, in the sense that investors do not try to time the market, by choosing an optimal time to invest.
The strategy is built on the concept of Dollar Cost Averaging in the US and what we would call Rupee Cost Averaging in India. The principle is that our investment will buy more units of the mutual fund when the NAV is low and less units when it is high. Consequently, the average cost per unit or share of the mutual fund will be lower than the average NAV. The latter is computed by giving equal weightage to all the observed NAVs. For instance, consider three NAVs of 25, 40 and 50. Assume an investor puts Rs 10,000 into the fund at each of the observed NAVs. He will receive 400, 250, and 200 units. The average cost is 35.29 whereas the average NAV is 38.33.
Start SIP at a young age
If you are starting a SIP, then start at a young age, for you are then giving your money greater time to grow. While the stock market can be very volatile in the short run, evidence indicates that over a period of time, stocks outperform other asset classes by way of returns. In terms of choices, people can invest in large cap funds or flexi-cap funds.
The latter flit from one category of shares into another, in terms of market capitalisation, based on the fund manager’s outlook on the market. Yet another alternative is investment in an index fund. Investors can also diversify between debt and equity by starting a SIP in a balanced fund, or by systematically investing in both equity and debt funds. There was a time when SIPs were recommended only for equity funds. They had the view that debt funds are more suitable for one-time lumpsum investments. But there seems to be a rethink on this philosophy.
The National Pension Scheme is also an attractive vehicle for a SIP. Investors can choose a mix of equity, corporate debt, and government debt. The cost of investment can be much lower in such an investment. In fact, SIPs can be initiated in foreign mutual funds as well by Indian citizens. It is not necessary to invest in a mutual fund from the standpoint of systematic investment. We could identify a few attractive stocks and put money into them at periodic intervals. This too would give the benefit of rupee cost averaging.
Systematic Withdrawal Plans
Systematic Withdrawal Plans require redeeming a fixed amount at periodic intervals from a mutual fund. This would appeal to retirees who need a steady income. This strategy may, however, lead to profligacy because if the amount that is received is greater than what is required, the balance will typically be spent on unwanted items of expenditure. Thus, some money managers hold the view that retirees should liquidate their mutual fund holdings as and when required, depending on their requirement for funds, instead of opting for a systematic withdrawal plan.
The writer is CEO, Tarheel Consultancy Services