SIP smartly 1: Testing the infallibility
MAS Team | 02 April 2013
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They get regular inflows on which they can charge fees (funds) and commissions (distributors). Most mutual fund schemes give the investor the option of monthly or quarterly investment. Financial planners and advisors advocate SIP probably because it has a veneer of method. If something goes wrong, you can also blame a widely-accepted method.


But beware; there are periods when SIP works and when it doesn’t, though we have not heard of fund companies or distributors tell you about when SIPs fail and why. SIP will work well over an investment period only if the two below-mentioned conditions are satisfied:

    Many of the purchases are made at a declining phase of the market;
    The market eventually turns up.

In this situation, every new purchase is made at a lower cost than the previous one, for several periods. Therefore, when the markets go up again, your average price would be lower than that of the initial purchase price. Thus, the investor would have made sufficient returns. Here is a chart to illustrate how SIP worked between 2000 and 2008. This is the best-case scenario for SIP, but not a typical one. In at least three cases where it will not work well:

    If the market is mainly down, not up. In this case, all your accumulated units are marked to a low final value;
    If the market goes sideways mainly. In this case, the average purchase price would closer to the final price. The returns will not be poor but not that great;
    If the market is headed down from a peak formed by huge overvaluation. The average purchase price, in this case, goes up compared to the final value as the purchases are made at the market peak.
If SIP doesn’t work on many occasions, what are these occasions and can we spot them? Yes, by some rigorous back-testing.

Kicking the Tyres
We tested the SIP strategy on the Sensex, over the period from January 1991 to May 2012. We compared the returns of a lump-sum investment made at the start of the period and a systematic investment of an equivalent amount made in the same period. The results: Both SIP and lump-sum performed equally over the one-year, three-year, five-year and seven-year periods. It might stun mutual fund companies and their distributors who blindly herd investors into a SIP regime, that in the three-year, five-year and seven-year periods, the probability of SIP beating lump-sum investment, taking any start point between starting from January 1991, would have been as good as tossing a coin! If this does not rattle all financial planners and advisors who blindly borrow ideas from the West and implement them here, we don’t know what will.

By increasing the investment term to 10 years, SIP did comparatively better, outperforming lump-sum investment on a greater number of occasions. We did a 20-year analysis as well, but due to the extremely low prices in 1991, lump-sum investing did better.