To Sip or not Slip

While we all learn from our childhood the importance of savings, Governments and experts believe that if left to our own devices, we would either splurge out or make wrong investments that is bound to hurt when we need it the most.

Using a combination of Carrot and Stick, the policies of the government try to ensure that one ends up with a decent amount of savings by the time of his retirement. So, a part of one’s income is deducted and which goes into a Provident Fund Account which over time, thanks to one’s own investment + employer’s contribution + the accruing interest makes it a sum worthwhile to retire upon.

Housing Loan payments are set off against tax liability to make it worthwhile (rightly or wrongly) for everyone who desires to get a roof above his head. Same goes for various other deductions which essentially  are investments for the future (one’s own or of ones children).

Investing in equities, specifically mutual funds has been pushed by providing various tax benefits, benefits that hopefully provide a impetus for the investor to make it a worthwhile asset class to invest, risk not withstanding.

One of the ways for many investors to invest is to set up a Systematic Investment Plan (SIP) so as to ensure

• A continuous contribution to equity which can provide a better return than other fixed asset classes
• Enable one to average out his purchase price by buying with total disregard to happenings in market

Systematic Investing is pushed a product for all seasons. Any attempt to provide perspective on the nature of the markets and hence how SIP’s can actually be detrimental to the wealth of a investor falls upon deaf ears and more fixed positioning.

Lets start with asking a basic question.

Who or what kind of Investor is SIP meant for?

The answer I have heard and read about is that this is the best and maybe only possible way for those with a full time profession and unable to understand the market or valuations as such. SIP is also a tool I am told that enables those with buttery fingers when it comes to spending to save a bit from their Income. In other words, SIP is a attempt to force those with no clue of markets to invest in the hope of a better tomorrow (which generally means a decade or two from now).

Despite the good (?) intentions, one of the cribs of fund managers is that even when people enroll for a long tenure of, say, five years, they generally stop after two-three years. Should not one question what makes one stop their SIP early than what they signed up for?

To me, the biggest reason would be under-performance. Just today I tweeted this

If the Mutual fund you are invested in has correlation of 1 to Nifty 50, any SIP started after November 2012 will be under water.

— Prashanth, CMT (@Prashanth_Krish) February 12, 2016

Being a full time professional I understand that markets moves in cycles and how even this bear market will end at some point of time. But what of a lay man who has been promised a CAGR return of 17% (since that is what Sensex has supposedly delivered) over time and how this is a way better investment than any other asset classes.

How many advisers out there start of by showcasing the risks that come with investing in Mutual Funds? Funds have dropped 50% / 60% and more from their high points. Is a lay investor ever educated with the risk he is taking?

In times like these, when theoretically one should be adding to allocation, those chaps would actually be jumping off the burning bridge. Its laughable when advisers say that they shall hand hold the client (and hence justify their fees) during tough times such as these and help them to continue investing.

But how many actually provide them with the real picture of what to expect and the probabilities of what is the worst case scenario’s. Most advisers try to shove the risk under the carpet while showcasing only the good parts. How different this is to real estate builders printing out brochures where it seems that you will be surrounded by nature when the reality is the fact is that the builder has absolutely no control of what happens outside.

Markets deliver higher returns because there is a risk involved, a risk that can lay waste to investments. Mutual funds can help by enabling one’s investment to be handled by a professional and by pooling reduces the risk of a single bad apple destroying the whole basket. But extrapolating the last 20 years over next 20 years which most advisers do while being the easiest path, is certain to bring disappointments on your way.

To conclude, SIP is a good way to instill investment disciple. But unless the risks are fully known and accepted, the risk of early abandonment after being disappointed is pretty huge. Preparing the investor for the risk rather than focus on reward (Gains / Goals) is a much preferable way.

Yet, despite all that, a investor who only knows to invest but is clueless about times when he should reduce is bound to get average returns and in-turn be disappointed by the whole system. There, only Allocation and continuous re-balancing holds the key to a more satisfied client and a better off investor.