August 28, 2015

the flip side of mutual fund & equity SIPs

No investor would not already be aware of SIP-based (systematic investment plan-based) investing, particularly in equity schemes of mutual funds and directly in equity shares of listed companies. Given the marketing motivation to entice investors to commit funds for a long term into SIPs, mutual funds and brokerage firms spare no effort to highlight the pros of SIPs.

Sure, systematic investing is a far better way to invest than irregular or lumpsum-based investing, but SIPs, the way it is marketed and promoted by the industry, is not the best way to reap the benefits of systematic investing.

Here is why.

The problem with MF SIPs
SIPs in mutual fund schemes suffer from mainly one, but severe, problem. It ignores the element of diversification which is crucial for any investment portfolio. An investor has a limited amount to deploy and scheme-specific SIPs tend to demand commitments of a higher sum.. Thus, if a large portion of deployable sum goes into a SIP of just one or at most a handful of schemes the investor is risking being caught in a vortex of badly performing schemes. For equity investors, there are over 200 equity schemes to choose from and it may not feasible for most investors to use SIPs for more than a handful of them. A SIP into a poorly-performing scheme can be disastrous.
The problem with SIPs in direct equities
The same problem of lack of diversification, like in MFs, applied to direct equity investments. You have limited amount of money to deploy in equity shares. SIPs force you to commit disproportionately high sums into a very few number of companies. Badly-performing stocks in your un-diversified SIP portfolio can destroy your wealth.
What is the solution
Investors must still do systematic investing but not through SIPs. With better technologies available in internet trading and mobile app-based trading by mutual funds and brokerage firms, it is easier to be self-disciplined and invest once every month in MF schemes or equities directly in a more-diversified set of MF schemes and stocks than what you would typically do in inflexible SIP plans that MFs and equity brokerage firms offer you.