You must know this about MF SIP returns

Amit TrivediMany investors ask about SIP. Some of the common questions pertain to enhancing the returns. Some questions are about which date to start the SIP from and some are about for what period. Some questions are about the frequency – whether daily SIP is good or monthly.We have seen many articles and blog posts arguing for or against many of the above situations. In almost each case, they pick up some data from the past and then highlight whatever the data concludes. If the data under analysis suggests that daily SIP has fared better over monthly, so be it. However, take a different period, and you may come up with exactly opposite conclusion. Similarly, based on the data taken one can come up with any conclusion to prove anything ranging from which SIP date is better or what SIP period is ideal or in which month should one start the SIP. So let us understand what contributes to the SIP returns. In a typical monthly SIP, one invests a fixed amount each month at the prevailing NAV. Units are allotted based on the amount invested and the prevailing NAV. Since the amount is generally constant, but the NAV keeps changing, the number of units one gets would be different from month to month. (As we know, the units bought would be equal to the amount invested divided by the prevailing NAV.) Let us look at some numbers. We have taken hypothetical examples of three schemes for the purpose of explanation.In all the three cases, the NAV has moved up from Rs. 12 to Rs. 14 over a 13-month period. We have also assumed the investor has invested Rs. 10,000 per month in each of the schemes for a 12 month period and the investment performance is compared at the end of the 13th month. Though the schemes’ start and end at same NAVs, in between the NAVs of these funds have taken different paths. The monthly NAVs (in Rupees) are as under:The scheme NAV movements are shown in the graph below: As can be seen, • The scheme 1 NAV initially went up and then came down, • In case of scheme 2, first the NAV went down and then came up, and• In the third scheme, the NAV went up in a straight line(Note: All these are hypothetical and not real cases. These NAVs are created only for the purpose of explaining a point)The point-to-point returns are exactly identical in all the three schemes, since the NAV moved up from Rs. 12 to Rs. 14 in 13 months.However, if someone did SIP in these schemes, the performance would look very different. The IRR for the three SIPs would be as under:It is not the start and the end only, but also the path traced that matters for the SIP investor. If more purchases have happened at lower than the redemption price, the investment returns are positive. However, if more purchases were at higher than redemption price, one would get negative returns.What does this mean? Actually nothing. Can someone predict what path a scheme’s NAV would take over the investment period? No.Does SIP make sense, if we cannot predict? To answer that question, we need to understand the nature of markets (though one can do an SIP in any fund – liquid, debt, balanced or equity; we will restrict our discussion to equity funds for the purpose of explaining our point).Nature of equity marketsLet us start with what the dean of Wall Street has said about the equity markets. In the words of Benjamin Graham, “Stock markets are like voting machines in the short term, but are like weighing machines in the long term.” The weight here refers to the long-term profits generated by the business. So long as the profits increase, the stock price should follow. However, this relationship holds true only in the long run.The votes are the opinions of various market players about the future of the company or the stock price. These opinions keep varying in the short-term, and change very often. Changes in the opinions make the stock prices volatile in the short-term. SIP in equity funds benefit out of these – long term positive returns and short-term volatility. The former boosts the power of compounding, whereas the latter helps acquire units at lower average price through a concept called “Rupee cost averaging”.Someone asked, “Is there a guarantee that long term returns would always be positive?” The answer is a clear “no”. There is no such guarantee – especially when the asset itself is risky. This person followed up with another question, “If there is no guarantee of upside, what if long term returns are negative? What should one do in such a case?” The answer is simple, “If you have a long term negative view of the markets, you should stay away from investing at all. Neither lump sum nor SIP should be recommended in such a case.”So, understand that SIP is not about being able to generate better returns than lump sum investing. It is about a disciplined investment approach that can extract benefit out of the nature of investments – short term volatility and long term upside.Happy investing.The author runs Karmayog Knowledge Academy. Views expressed here are his personal views. He can be reached at amit@karmayog-knowledge.com.