Does SIP have any limitations?

My article in Mid-day Mumbai edition today. Click on the link below to read:

http://epaper.gujaratimidday.com//epaperpdf/gmd/30112015/30112015-md-gm-10.pdf



Th English translation is as under:

Very often people ask this question, “So many financial advisors keep talking so many good things about SIP. Is there anything negative about it?” Come to think of it. Can there be something that is only good and without any limitation?

Well, SIP is not without any limitations. It has two serious limitations.

(1) That the asset prices have to go up in the long term, and

(2) During the investment period, even when the market is at a high level the investor keeps investing (though one buys fewer units)

Well, some may argue that these limitations are not very serious or that these are no limitations at all. Even if someone believes so, let us look at the word “limitation” with an objective to explore if there could be something better.

Incidentally, there is, at least in theory.

Let us look at the second of the limitations we have highlighted, that in SIP, we keep investing even when the markets are at high levels. The advocates of SIP would argue: Is it possible to know in advance if the markets are high or low? And since we do not know in advance, we keep investing and the principle of “Rupee Cost Averaging” takes over.

This principle of Rupee Cost Averaging helps us reduce the cost of purchase. When we invest a fixed sum of money in equity mutual funds, which have volatile NAVs, we buy more units when the NAV is low and fewer when the NAV is high. This happens automatically since the units allotted are a function of the amount invested divided by the prevailing NAV. This, by itself, turns the stock market’s inherent volatility do work for the investor.

However the fact remains, even though one buys fewer units, one does buy something even at market peaks. Let us see if at market peaks we can stop our investments or even take some money out of the investments.

Michael Edleson, a former professor at Harvard Business School promoted an approach that can improve upon the SIP. This approach does not keep the investment amount constant, but changes it – either the amount is increased or decreased. Incidentally, the investment amount is increased when the markets are low and vice versa. This approach is popularly known as “Value averaging”.

While in case of SIP, the regular investment is kept constant, in value averaging, the attempt is to keep the monthly (or whatever period one has chosen) value constant. As we all know, the value of investments (NAV of an equity mutual fund) would regularly change in line with the movement in the market prices. When this happens, the fresh investment amount would be adjusted such that the value is restored to a predecided level. We will continue with the discussion and also use illustrations in the next issue ...

-        Amit Trivedi

The author runs Karmayog Knowledge Academy. Recently, Amit has authored a book titled “Riding the Roller Coaster – Lessons from Financial Market Cycles We Repeatedly Forget”. The views expressed are his personal opinions.

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Tame the volatility of equity markets with asset allocation

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The English translation is as under:

Last time we wrote about the power of SIP to tame the risk of price volatility. However, this is suitable for individuals having regular income and savings. Someone may wonder, what about those who do not have regular savings? What about the retired investors?

Retired investors invest their money and then draw regularly out of these investments. Many are comfortable with fixed income investments and get the regular income in form of interest. On the other hand, there are some who invest in mutual funds and withdraw their money regularly. At the same time, in case of some, they may have money that may remain invested without any withdrawal from the same.

In fact, it is not just retired investors; many investors from other categories have some money that need to be untouched. No income may also be required out of the same as some other investments may be generating enough.

If such money is going to remain invested for long periods of time, one need to find how much should be invested in the volatile asset class called equity and how much in safe fixed income investments. This process is popularly known as asset allocation. (Asset allocation may involve investment in many other asset categories apart from equity and fixed income, e.g. real estate, international stocks, currency, etc.)

The big question in deciding the asset allocation is: “How much money should be allocated to which asset category?” The answer depends on three things: (1) the need to take investment risks, (2) the ability to take such risks, and (3) the willingness to take risks. One can have a separate detailed discussion on these three. However, broadly, the need to take risks arises when one needs returns higher than the safe short-term Government securities. The ability depends on one’s financial as well family situation and the willingness is a function of how soundly one can sleep at night after making certain investments.

Once the allocation is made to various asset classes, one has choices (1) let the allocations change in line with changes in asset class performances, or (2) rebalance the asset allocation to the original ratios, or (3) take market views and increase or decrease the allocations to various asset categories based on one’s views on the relative attractiveness. Most investors would be better off with taking the approach number 2.

Let us understand this approach, known as rebalancing the asset allocation to the original levels.

Let us assume that after assessing the needs of one of the clients, the advisor recommends investment of 50% of the assets in an equity mutual fund and 50% in a money market mutual fund. The investor and the advisor then decide to review the performance of the portfolio every six months. The review process is also very simple. The objective would be to maintain the allocation between equity fund and money market fund at 50:50.

Given that the stock prices are volatile over shorter terms and move in line with the profits of the company over longer periods, we are likely to see the value of the equity mutual fund go up and down over time. When that happens, the asset allocation would stray from the 50:50 that was set originally.

When the equity prices move up faster than the debt prices, the allocation will get skewed in favour of equity and our review process would restore it back to 50:50 by shifting some money from equity fund to debt fund. In the other case, when the equity prices move adversely, the balance would get skewed towards debt and the balance can be restored by shifting from debt fund to equity funds. What you are doing here is selling equity when the prices run up and buying when the units got cheaper. One is able to do this without having to worry about analyzing what is happening in the market place.

The above example is applicable to an investor, who has a static portfolio without any additions into the portfolio or withdrawals from the same. In reality, the investor may get inflows, which need to be invested in the portfolio or have a need to take some money out of the investments. In such cases, at the time of investment or redemption, the investor has to look at the current market value of the equity fund and debt fund and rebalance the portfolio to 50:50.

Automatically, the money goes into equity fund when the stock prices are low and into debt fund when the stock prices are high.

The only problem with the above is that what looks so simple is very difficult to execute since the approach means ignoring all the sound bytes taking place around you. It takes a lot of courage to chart one’s own course and more importantly, to continue walking that path – at times, all alone.

Maintaining the asset allocation helps an investor work the volatility in one’s own favour.

Wish you all a very Happy New Year!

-        Amit Trivedi

The author runs Karmayog Knowledge Academy. Recently, Amit has authored a book titled “Riding the Roller Coaster – Lessons from Financial Market Cycles We Repeatedly Forget”. The views expressed are his personal opinions.

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Volatility in the markets - friend or foe?

Small investors should take advantage of the inherent volatility in the stock markets and not get scared of the same. Read on ...


The English translation is as under:

A newspaper article caught my attention recently. The headline said, “Stock market might remain volatile”.

The word “volatile” or “volatility” often evokes negative emotions and many associate the term with falling prices. However, the word itself means the prices can move in either direction – up and down. In that case, is this really news? Stock markets have always been volatile. As I have written n my book, “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”, “As long as decision-making is involved with different people having different motives, their opinions, decisions and actions themselves are going to move the financial markets in either direction.

Remove that from the market and voila, you don’t have a market at all. If all the individuals have the same information, same motives, same actions to perform, no trade can happen. For someone to buy, there should be someone to sell and vice versa.

The presence of a large number of people in the market, transacting on the basis of different motives and biases, makes the markets what they are.

Many get scared of volatility. Many stay away from the stock markets due to the inherent volatility of the markets. The fact is, normal markets are volatile and volatile markets are normal.

It is crucial to accept this fact.

The volatility is not bad. It simply exists. While, one can lose money on account of it, it gives profit opportunities for the traders and speculators; it also provides liquidity to the long-term investors, whenever they require. In the absence of volatility, the traders would not be interested in trading. The reduction in trading volume would kill the liquidity. This would have severe implications for long-term investing.

In such a case, it is upto one to decide whether to be scared of it or use it to one’s advantage.

So the question is: how can a small investor use volatility to one’s advantage?

There are a few proven strategies that one may adopt.

At the outset, let us understand that in stock markets, short-term price movements are more volatile than long-term movements. At the same time, the potential to offer higher-than-inflation is high if you hold your investments for long period (Assuming you hold a diversified portfolio of good quality stocks). With that in mind, stay away from equity markets, if you are going to need the money in the short-term. This will reduce the impact of volatility on your portfolio.

Second, if you are in your earning years, you should focus on saving some of your earnings regularly. Keep an eye on your expenses. The savings thus generated can be invested in the form of systematic investing (popularly known as SIP). This is a wonderful investment plan. On one hand, it allows one to invest one’s regular savings in a productive manner; it also makes the inherent stock market volatility to work for the investor. Since one is investing a fixed sum of money regularly, the units acquired each month are a function of the fund’s NAV.

An investor is allotted units based on the amount invested and the fund’s NAV. When someone invests Rs. 50,000 when the NAV of the scheme is Rs. 250, one gets 200 units (Rs. 50000 / Rs. 250 = 200). However, at the time of the next investment if the NAV has gone down to Rs. 200; the investor would be allotted (Rs. 50000 / Rs. 200) 200 units. As you can see, the investor got more units when the NAV was low and fewer when it was high. Thus, the average cost of purchase comes down. SIP makes the volatility work in the favour of the investor.

Next time you read about volatility, laugh it off. Volatility in stock markets is like the seasons, there would be summers and winters. You don’t wish them away. You learn to enjoy the beauty in the seasons. Same applies to investment markets. So don’t get scared of volatility. Simply set up an investment plan and stay put.

-        Amit Trivedi

The author runs Karmayog Knowledge Academy. Recently, Amit has authored a book titled “Riding the Roller Coaster – Lessons from Financial Market Cycles We Repeatedly Forget”. The views expressed are his personal opinions.