It is a way for regular investments, overcomes greed-and-fear cycles

WHETHER systematic investment plan (SIP), where investors allocate certain fixed amount into stocks/bonds at regular periods, or lump sum investment, would generate better returns has always been a point for debate among market participants.

Analysts at MorningStar India, a mutual fund tracker, tried to look at how things would pan out on the ground in India after a research from US-based mutual fund giant Vanguard said lump sum investment generated better returns for two-thirds of the time after portfolios were allocated going back to 1926 in the US, 1976 in the UK and 1984 in Australia.

Vanguard tested a variety of allocations ranging from all-stock to 60:40stock:bond to all-bond, and looked up the result for rolling 10-year periods (that is, from January 1926 to December 1935, followed by January 1927 to December 1936, and so on).

Their conclusion was lump sum investment portfolios outperformed dollar cost averaging (aka SIP) portfolios 66 per cent of the time for 100 per cent equity, 67 per cent for 60:40 stock: bond and 65 per cent for 100 per cent bond in the US.

Similar results were seen across the UK and Australia data. However, things may not work similarly in India.

MorningStar India said given an average investor putting any amount to invest via lump sum, and more likely to put it to work at the wrong time, that is, around the peak of a euphoric market when valuations are rich and the investment is more likely to lose money rather than at the trough of a bear market when recent returns have been poor but compellingly cheap, will result in greater future gains.

That small investors poured huge sums of money into stocks/stock mutual funds at the height of the 2007 bull-run, compared with outflows after the 2008 crash bear testimony to this point.

A similar back-testing exercise was done by Quantum Mutual Fund in India on SIP, value averaging investment plan (VIP) and lump sum investment. Jimmy Patel, CEO of Quantum MF, said both SIP and VIP returned matched in India, and both are ahead of lump sum investment. In the case of three year data, though value SIP may beat plain vanilla SIP, but after deducting for exit loads, both the SIPs generated better returns.

A VIP is an investment strategy that works like an SIP – you invest on a pre-determined date, into a fixed mutual fund scheme, thus achieving the purpose of disciplined investing and following the teachings of finance gurus when they say `buy low'.

But, while in an SIP , the amount is fixed and units may change, in a VIP , you have a target value of your portfolio, which increases by say Rs x,000 per month, and you invest the difference between the current value of your portfolio and the targeted portfolio investment value. By buying more when markets go down, you are also benefiting from the concept of rupee cost averaging.

Investing regularly also inculcates financial discipline, and you don't have to worry about too much paperwork.

Sameer Kamdhar, a mutual fund analyst and former CEO of ASK Investment Managers, said: "SIP gives you a disciplined investment approach. Buy low and sell high approach has never worked in Indian market for small investors. For salaried people too, SIP is much better suited."

Kamdhar also highlight ed the way investors reacted in India during past bull phases (they entered at near-peaks) and bear phases (when they exited at rock bottom levels) to show that SIP was a better investment strategy in India.

Patel of Quantum MF, added: "SIP investors tend to scare less easily than lump sum investors when the markets fall, as they get the chance to buy low, and later when they want, sell high".

In the study by Quantum, it was found that three to five years after completing a 12month VIP, the returns under the VIP method and SIP method are almost same. The convergence of returns happens post the last payment of instalment of SIP/VIP over a period of time, wherein, the true benefits of equity investments gets captured. Initially, at different levels, SIP and VIP showed performing better than the other, but ultimately in the long run, both give similar returns.

"….SIP scores over VIP in ensuring discipline of investments and over a long period of time gives return similar to that of VIP while doing away with risks of forced redemption or requirement of additional surplus cash for investments. SIP captures the potential of extracting a better valuation when investing in falling markets, while it also averages out risk of investing in a rising market," the study said.

The idea of an SIP is simple and forceful. It, by default, not only paves the way for regular investments, but also eliminates the behavioural greed-and-fear cycle, which could otherwise make the investor over or underinvest during up or down markets