Be innovative while investing via SIPs

Systematic Investment Plans (SIP) has been a pet product for investors looking to contribute money towards a targeted goal through mutual fund (MF) investments. The success of SIP has been the simplicity i.e., to initiate, contribute and execute a SIP while bringing much needed discipline to the investor which would remain a hallmark of any successful equity investment.

It also helps one to latch on to the supposedly eighth wonder of the world, the power of compounding, which could be great wealth enhancer in the long-term and without even worrying about timing the market.

MF SIP investments offers two huge risk mitigation advantages that are otherwise associated with equity investment risk. One is the Rupee Cost Averaging - No one is sure if their price of entry is cheap, expensive or fair-valued.

By investing in an asset in a staggered manner (systematic) the overall cost of acquisition is averaged. Second is the volatility - equity markets are always dynamic and price movements are a constant feature.

By spreading your investments, one could invest a piece of their investments when the markets are relatively high and as well as low. This enables investor to reduce the risk over long period.

With the changing times, SIP has shown signs of evolution and has taken transformation. Now, we have tweaking to the traditional SIP that makes it more agile and responsive.

The value-averaging SIP is done where the contribution is relative to a desired return target. These could be simple top-ups where a particular rate of increased every year on a monthly contribution.

The top-up, however, is pre-defined for a certain period starting at a particular point of SIP beginning. This seemingly simple arithmetic could add huge advantage in the long run as one increases the contribution which will have a huge rubbing on the compounding.

With a gradual increase each year, say 10 per cent of the existing SIP, the contribution does not pinch the subscriber.

The other variation is the SIP based on the valuation of the market. We keep on hearing that one should invest when markets are low and pull out or score profits when they are high.

How does one reason if the markets are low or high. Price Earnings Ratio or P/E ratio is a measure that reflects the valuations of the markets. Theoretically, a P/E of 15 and below is considered as low while that of 22 is seen as high.

Keeping the NSE NIFTY 50 trailing P/E as the benchmark, the fund increases or decreases the contribution. When the P/E are high, the fund allocates lower than the actual SIP amount while at the low P/E pumps in higher contribution than the actual. This way one could make productive investment into equity markets through SIP.

However, a range needs to be defined for the monthly contribution based on market P/E without which the amounts could go varied. And also, this is a bit complex in terms of execution as the ensuring larger buffer in the bank account is required especially during the lower P/E multiples of the broader markets.

On comparing the two variants in relative to the traditional SIP, the amount of contribution would generally be higher in the case of value-averaging SIP as the monthly SIP amount varies at the fixed rate.

However, the contribution to market P/E based SIP could be lower or higher over the traditional SIP depending up on market conditions.

As per a back test from value research online, considering the past 15 years at an assumption of Rs 5,000 every month in an average open-ended multi cap fund with a target return of 12 per cent per annum for value-averaging SIP; lower and upper limits of P/E based SIP at Rs 1,000 and Rs 10,000 the following numbers follow.

The total investment in a traditional SIP is Rs 9 lakh to that of Rs 10 lakh with valuation average facility and Rs 7.09 lakh in a value-averaging SIP.

The average annual return has been 13.75 per cent, 14.23 per cent and 14.82 per cent with worth of investment turning into Rs 27.69 lakh, Rs 34.41 lakh and Rs 24.93 lakh respectively. The important consideration is the discipline to continue these investments over 15 years to enjoy in whichever is the category.

(The author is a co-founder of "Welocity", a wealth management firm and could be reached at [email protected])