Monday, November 30, 2015

Does SIP have any limitations?

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

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.

1 comment:

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