All You Wanted To Know About SIP

Is rupee cost averaging effective across all market phases, including uptrends, consolidations and downtrends? You probably might not have observed its performance in each phase or may have exited investments upon seeing negative returns. Rakesh Deshmukh takes a closer look at the scenario. 

You have likely heard from friends, colleagues or mentors the adage of ‘buy low, sell high’, which means purchasing securities such as stocks, commodities or any asset at a low price and selling them at a higher price to generate profits. Perhaps you have attempted this strategy yourself, aiming to buy at a low price and sell at a high price. However, the primary challenge you may encounter is determining what constitutes a low and high price. 

It’s true that in the stock market, pinpointing the exact lows and highs is not as easy as it sounds. It demands extensive calculations, assumptions, experience, knowledge and skills to gauge these levels accurately. Despite putting effort, there is no guarantee of identifying the precise highs and lows of securities. Even many accomplished investors or traders have made incorrect predictions numerous times given the unpredictable nature of the market. There is no universal rule to define the market’s low and high points. 

It’s all about probabilities. Even if you find the lows it requires a lot of courage to buy at the low point. If we cannot predict the proper highs and lows of the market or any security, what is the solution? Well, the solution is to invest regularly, irrespective of the time or phases of the market, in a disciplined manner. We  have already opted to invest small amounts of our hard-earned money regularly, whether monthly, quarterly, half-yearly or annually, into selected mutual funds via SIP, which stands for systematic investment plan. 

Defining SIP
SIP is a method of investing in mutual funds where investors contribute a fixed amount of money at regular intervals, typically monthly. These contributions are used to purchase units of the chosen mutual fund. It is a disciplined approach to investing and helps investors to avoid trying to time the market, as it allows them to invest consistently over time regardless of market fluctuations. Ever think about what makes SIP a good medium for regular investment? Well, it’s the rupee cost averaging it offers. 

When the prices are low, the fixed investment amount (SIP) buys more units or shares of the investment, and when the prices are high, it buys fewer units or shares. Over time, this strategy results in the average cost per unit or share being lower than the average market price, as more units are acquired when the prices are low. Rupee cost averaging helps reduce the impact of market volatility on the overall investment and encourages investors to focus on long-term performance rather than trying to time the market. 

Does rupee cost averaging perform during every phase of the market, such as uptrend, consolidation or downtrend? You may not have noticed its performance across all these phases or may have exited your investments during a downturn. Recall the scenario of the last downturn, like the corona virus-triggered pandemic when markets were falling sharply. In this report, we will analyse rupee cost averaging during all phases of the market. 

From Bullish to Bearish Phase
Let’s begin analysing the scenario when the market was in an uptrend, specifically during the period 2006 to 2008 before the crash. At that time, Nifty was around the level of 2,800 and eventually peaked at a high of around 6,360 in the year 2008 before the market crash. Subsequently, the market fell back to around the same levels where you initially started investing, which was in October 2008. If you sold your investments upon seeing the market, which returned to the same levels, the following would be the result of your investment values of ₹1,000 SIP investments made every month during this period. In this phase, you must have experienced a bullish phase earlier and then eventually a downturn.

 

With a loss of over 31 per cent in absolute terms or around 24 per cent fall in your investment in terms of annualised returns, did rupee cost averaging work here? No, it did not. 

From Bearish to Bullish Phase
Let’s say you started investing during the peak of the market in 2008 before the market crash. The following would be the result of your ₹1,000 SIP investments made every month.

 

See how the rupee averaging cost worked very well on account of buying more quantity with the same SIP amount every month when the market was falling. If a little consolidation were there, it would be the cherry on the cake, as the price may be almost there, but the quantity will have accumulated during the consolidation phase. At a time when the market turns bullish or towards the upside, the potential of rupee averaging cost becomes even more magical. 

From Upside to Sideways and Eventually Fall
If you had started investing and bought low, enjoying the rally towards the upside, and then experienced a significant downturn after a good consolidation, the result of the investment value during the same period would likely show a decrease in value. 

The loss of investment value is not as significant as what we observed in the first phase analysis, where someone started buying during the low point, experienced the bull trend, and then encountered a significant downtrend. 

From Upside to Sideways and Eventually Continuing the Trend
In this scenario, where the market dipped to significant levels from its peak levels, investors found a good opportunity to start investing via SIP of ₹1,000 monthly. After showcasing a good rally, it consolidated for a long time, and instead of breaking towards the downside, it continued the rally towards the upside. 

It can be analysed from this that breaking out of consolidation and continuing the previous trend is better than the breakout from consolidation against the previous trend. For better clarity, compare the above returns with the last phase ‘from bullish to sideways and eventually fall’ return. Below are the scenarios analysed and presented graphically.

The basic concept of rupee cost averaging in a SIP is to profit from investments. Investors are advised to buy units when the market is low and sell them when they are high. However, due to a lack of investment knowledge, many investors avoid investing when the market is low out of fear of losses. Instead, they tend to buy when the market is up and sell when it is down. 

One can notice from that above data that the number of units increase during bear markets, but the value of the investment rises during bull markets. Both of these forces combine to have a cumulative effect in the long run and contribute to the power of compounding 

There are certain important points to keep in mind:
1. To benefit from rupee cost averaging, investors must experience the complete market cycle. This implies that investors have undergone all phases of the market while investing through SIP, which may take 5-7 years depending on the market.
2. It is also important to check when the investor started investing, in which phase, how long they continued, and at which phase they exited by selling all the units of their mutual fund. Additionally, it’s crucial to determine which phases the investor experienced since they started their SIP.
3. The duration of the investment tenure and the duration of market phases are also important points that investors should keep in mind to realise the actual benefits of rupee cost averaging. 4. Investing more when the market or unit price of mutual funds is low compared to its 52-week highs or its period peak levels is a wise decision to capitalise on the magic of rupee cost averaging. 

Advantages of Rupee Cost Averaging
■ Reduced Impact of Market Volatility: Rupee cost averaging helps reduce the impact of market volatility on investments. By investing a fixed amount regularly, investors buy more units when the prices are low and fewer units when the prices are high. Over time, this can result in a lower average cost per unit. 

■ Lower Average Purchase Price: Investing regularly allows for buying more units when the prices are low, reducing the average purchase price over time.

■ Eliminates the Need for Timing the Market: Timing the market is challenging and often leads to poor investment decisions. Rupee cost averaging eliminates the need to predict market movements, as investments are made consistently over time. This reduces the risk of investing a large sum at an inopportune time. 

Conclusion
In conclusion, rupee cost averaging through systematic investment plans (SIPs) offers a disciplined approach to investing, mitigating the impact of market volatility and eliminating the need for precise market timing. While it may not guarantee immediate gains in every market phase, its long-term benefits become evident over the complete market cycle. By consistently investing over time, investors can potentially lower their average purchase price, thus enhancing returns and reducing the risk associated with attempting to time the market. Overall, SIPs provide a prudent strategy for investors to navigate the uncertainties of the market and focus on achieving their long-term financial goals.