Complete Investor Guide to Building Wealth with SIP

SIP are one of the most popular ways to invest for millennials. Every month more people are adopting this investing strategy for creating wealth, retirement & long-term needs. In this post, we take a detailed look at systematic investment plans. We shall understand it’s benefits, it’s construct, how to take big advantage of SIP, how to calculate returns and the best SIP to invest in.

What is an SIP?

SIP or Systematic Investment Plan is a simple yet powerful system designed to help you create wealth. Under an SIP, the investor puts in a specific amount of money at a specified time. For example – an SIP is when you investing ₹1,000 every month for the next 10 years in a mutual fund.

SIP is also popularly known as dollar cost averaging in other countries like the United States. An SIP is tipped as the ideal way of investing in mutual funds for beginners and regulars alike. I have been using SIPs or systematic investment plans for a while now.

OK. Here’s why I like to use the SIP investing strategy?

I find that SIPs build a discipline towards savings & investing and it does so in a manageable manner. This is unlike other investment avenues like real estate which require investors to put in big sums at one shot and then wait years for fruition.

SIP = Wealth Creation

Systematic investment plans are excellent wealth creation vehicles. Money is invested on a quarterly, monthly (most popular frequency), weekly or even daily basis that compounds over time. These incremental additions sum up & accelerate in a growing equity market to offer a big bounty in the long run.

For example –  the HDFC Equity Fund is the flagship fund of HDFC Mutual Fund. The scheme started in January 1995. In over two decades, this fund has a return of 18.73% per annum. Therefore, the fund grew my last year’s corpus by 18.73% the next year and repeatedly did that over 24 years! No wonder Albert Einstein calls Compound Interest, the eighth wonder of the world.

Let’s put these in absolute numbers. If I had invested ₹10,000 on 1st Jan 1995, the same would have grown to ₹6,15,816 in 24 years.

If I had started a monthly SIP of ₹1,000, I would have invested a total of ₹2,88,000 over 24 years (i.e. ₹1,000 multiplied by 24 years multiplied by 12 months in each year). And my HDFC Equity Fund corpus would be at a whooping ₹55,65,230. That’s a wealth generation of ₹52,77,230 over the ₹2.88 lacs I had originally invested. This is the power of SIPs!

How SIP works?

The simplicity of an SIP is what makes it work. Here are the steps –

• On a pre-determined day, money is automatically debited from your bank account and invested in a mutual fund.
• The mutual fund issues units at the price (called NAV or net asset value) of the fund on that day
• The investor continues to collect units as an when more money is invested with units allocated per the NAV on investment day
• The investor can pull out some or part of his money by redeeming some part (or all) of the units. The money will get credited back to his bank account within two to three days. The redemption will be at the price of the unit on the day of redemption

Let’s understand Systematic Investment Plans (SIP) with an example.

Starting an SIP

• Today is 1st January 2019 and you start an SIP today in Franklin Prima Fund (a midcap fund). A monthly investment of ₹10,000 will be debited from your savings bank account on the 1st of every month
• The NAV of the fund is ₹50 on 1st January. So after applying your ₹10,000, the fund allots you 200 units i.e. ₹10,000 divided by ₹50.
• All through January, you hold these 200 units however since NAV changes everyday, the value of your portfolio changes everyday.

• Your second installment of ₹10,000 comes on 1st February 2019. The NAV on that day is ₹52 which means you will be alloted 19.2307 units.
• By the end of 1st February 2019, you would have accumulated 392.3076 units i.e. 200.0000 units from January and 192.3076 units from February
• And the sequence continues …

Let’s assume today is 14th December 2019 and you want to see how your SIP portfolio has performed. Here’s how your SIP statement will look like –

Over the last 12 months, you have invested ₹1,20,000 (i.e. ₹10,000 x 12 months). You have been allotted 2239.6390 units, which at the present NAV of ₹56.1554 gives you a portfolio value of ₹1,25,768.

Redeeming Mutual Fund Units

With Christmas approaching, you need some money – ₹60,000 to be precise. Afterall your brother has been nagging you for that beautiful Apple iPhone XR (128GB) which is available on Amazon.com.

It’s 14th December 2019 and there is a flash sale at Amazon which ends on 18th December 2019. That’s just in time to get your account credited with the redemption proceeds from your mutual fund unit sale. Here’s what you do –

• On 14th December 2019, you have a portfolio of ₹1,25,768 with 2239.6390 units
• You place a redemption request for ₹60,000. This translates to 1068.4636 units that need to be pulled out from your current portfolio
• The new balance at the end of the day will ₹65,768 or 1,171.1754 units

The above example shows how you can utilize your SIPs for creating wealth. Your investment was ₹1,20,000 over 12 months and your portfolio had jumped to ₹1,25,768 giving you a profit of ₹5,768 at an XIRR of 9.88%.

Four Important Characteristics in SIPs

Now that we have seen how an SIP works, here are four things you need to make a note of –

1. Units and NAV (net asset value) are generally displayed and reported in 4 decimal places.

This is done so that there is greater accuracy in allotment and redemption of units. Let’s examine this with an example –

• You have launched a mutual fund with ₹10,00,00,000 collected from investors in an NFO (new fund offering; term used when a scheme is floated for the first time)
• You break this down to 1,00,00,000 units of ₹10 each
• The first day itself your stock picks do extremely well and your fund’s value grows to ₹10,15,41,086. No additional units were bought on the first day. This means the NAV of one unit is now ₹10,15,41,086 divided by 1,00,00,000 units

Now, lets understand the impact on your corpus because of having 0, 1, 2, 3 or 4 decimal places in the NAV

• At zero decimals – the NAV will remain at ₹10. As a result, we are not accounting for a huge ₹15,41,086
• If we use one decimal – the NAV will be ₹10.1 or ₹10.2. At ₹10.1, there is an under-reporting of ₹5,41,086). And at ₹10.2, there will be an over-reporting of ₹4,58,914
• The use of two decimal places the NAV at ₹10.15. This is an under-reporting of ₹41,086
• At three decimal places, the NAV will be ₹10.154. In this case, we will be under-reporting by ₹1,086
• And at four decimal places, the NAV will be ₹10.1541 and your corpus will be under-reported at ₹86

Four decimal points works the best for NAV and units.

2. You won’t know the day’s NAV while executing the day’s buy or redemption order.

The NAV for the day is released only around 9 p.m. with some fund houses declaring at 11 p.m.

3. Redemption orders can be placed on a unit basis or an amount basis.

This provision allowed us to place a redemption of ₹60,000 (amount) for the Apple iPhone XR we wanted to purchase.

4. XIRR (or Extended Internal Rate of Return) is the correct financial metric used to calculate your SIP returns.

This formula is widely used to calculate return on investment when there are multiple transactions that are happening at different times.

Benefits of Mutual Fund SIPs

SIPs are getting popular by the day. In February 2020, over ₹8,500 crores ($1.2 billion) of money was pumped into SIPs by domestic investors. The benefits of SIPs are many –

1. Discipline in Savings
2. Invest small but make big portfolio gains
3. Flexibility
4. Convenience
5. Professional Expertise
6. Higher returns
7. Ease off market timing pressures

In addition to these benefits, there are a number of myths and misconceptions associated with mutual fund SIP which are –

1. Only small investors go for mutual fund SIPs
2. SIP have a different treatment as compared to lumpsum investments
3. Missing an SIP leads to penalties
4. Entire money can be withdrawn after 3 years in a tax saving SIP

SIPs are the perfect tool for long-term investing

How to eat an elephant? …. One bite at a time

Long-term goals are best served and achieved when it is broken down into manageable units. The goals need to be measured regularly and improved from time-to-time. If you want to geek it out, do subscribe James Clear’s blog where he writes about productivity & related subjects. My favourite ones are Goal Setting and Habits.

SIP is a habit which can lead to the achievement of your long-term goals. Goals can be of any duration like buying a house, buying an expensive car, travelling abroad, retirement, children’s education etc. Your dreams become goals when you have a plan & strategy on how you can get there.

There are five areas you need to master with regards to SIP for long-term wealth creation –

1. Importance of equities in long term wealth creation through mutual funds
2. The Power of Compounding
3. How to calculate monthly SIP amount on MS Excel
4. Can SIPs make you rich?
5. Best Mutual Fund SIPs to Invest for the Long Term

5 New Strategies to Find the Best Mutual Fund SIP

Identifying the ideal SIP requires investors to look at some key considerations. These can help you chart a powerful SIP strategy that can build big wealth over the long-term.

1. Keep a 5+ year perspective on SIPs

Mutual funds can be purchased as a lumpsum investment for a tactical short-to-moderate term. However, equity mutual funds for SIP are always bought for the long-term i.e. 5 years and more

Example of a lumpsum tactical investment. The NAV of Reliance Banking Fund crashed by 60% within six months of the 2008-2009 global financial services crisis. It was a great time to make a lumpsum investment as banking stocks were available at deep discounts. Similar opportunities are available with flippant oil prices, gold and sudden economic shakeups like demonetization, war, drop in GDP etc.

However starting an SIP based on cyclical opportunities is not a good idea. Thus, our first lesson to selecting a mutual fund SIP is to go for a diversified one and not a sectoral one. Mutual funds types that are diversified across sectors are multi-cap funds, large cap funds and large & mid-cap funds.

At the time of writing this article, the top 3 funds in the above three categories (min 5 years return) are –

Multi-cap funds

• Reliance Focused Equity Fund (21.68% over 5 years; ₹4,153 crores AUM)
• Franklin India Focused Equity Fund (19.84% over 5 years; ₹7,445 crores AUM)
• SBI Focused Equity Fund (19.39% over 5 years; ₹3,580 crores AUM)

Large cap funds*

• Reliance Large Cap Fund (17.32% over 5 years; ₹11,694 crores AUM)
• SBI Bluechip Fund (15.71% over 5 years; ₹20,395 crores AUM)
• HDFC Top 100 Fund (15.14% over 5 years; ₹15,163 crores AUM)

Large & Mid cap funds

• Mirae Asset Emerging Bluechip Fund (26.39% over 5 years; ₹6,444 crores AUM)
• Canara Robeco Emerging Equities Fund (26.14% over 5 years; ₹4,190 crores AUM)
• Principal Emerging Bluechip Fund (22.39% over 5 years; ₹3,580 crores AUM)

* Omitted funds whose AUM is less than ₹1,000 crores.

2. Balance your asset allocation with the SIP you are selecting

Often users buy the same type of mutual fund under the lumpsum and SIP program. This is an exercise in ignorance as the investor has no idea how their portfolio is shaping.

In other words, the purpose of diversification and lowering of portfolio risk is defeated if you have too many large cap fund purchases.

Your focus should be on optimizing your mutual fund returns and reducing your mutual fund portfolio risk.

While selecting a mutual fund, do have a clear understanding of your current and targeted asset allocation. I put about one-third of assets in debt instruments (debt mutual funds and fixed deposits) and the remaining two-third in equity instruments.

Let’s learn a bit about equity funds. They come in two types –

1. Equity mutual funds and direct purchase of stocks
2. Arbitrage mutual funds

Investments in equity arbitrage mutual funds is used as a parking area for funds until the markets move in a favourable direction. This is true in the current market where Nifty50 is close to 12,000 points. A number of investors are uncomfortable committing a large portion of my portfolio to equity instruments.

How I allocate assets in my mutual fund portfolio?

Among my equity investments, I tend to follow a split of 55% large cap funds, 30% mid cap funds and 15% small cap funds.

I am comfortable with above asset allocation.

The above asset allocation forms the basis for my decisions on which lumpsum or SIP I should buy, pause, cancel or redeem. If I ever to replace a large cap SIP with a small cap SIP, then it will disturb the asset allocation. As a result, I give a hard look and thought to my mutual fund decisions and only make necessary modifications. I generally wait for my 6-month rebalance period to come up.

Rebalancing is a very effective technique which can help you earn an additional 1-2% returns from your investments.

The learning here is that the SIPs you select needs to be in sync with your asset allocation.

3. Mutual fund AUM is an important consideration

The investment community has written at length on the insignificance of AUM or Assets Under Management of individual schemes. There are two reasons why some players don’t like to offer much credence to the scheme’s AUM –

1. Introducing new schemes is important for the fund houses to keep their advisors and distributors excited
2. If investors continue to invest in the older, bigger schemes – the fund houses will make less money

Surprised on point 2?

Let’s look at how the mutual fund companies (also called asset management companies) charge from consumers.

Expenses charged by mutual fund companies

The Scheme Information Document of Reliance Large Cap Fund states that the total expenses of the scheme including the investment management and advisory fee shall not exceed the limits stated in Regulation 52(6) which are :

1. On the first ₹100 crore of the daily net assets — 2.50%
2. ₹101 to ₹400 crores of the daily net assets — 2.25%
3. ₹401 to ₹700 crore of the daily net assets — 2.00%
4. On the balance of the assets — 1.75%

The above slab shows that schemes which cross ₹700 crores can charge 1.75% from the daily NAV.

The larger the AUM of the mutual fund scheme, the less they will be able to charge the investors as fees. This is enough incentive for an AMC to launch a number of new schemes to keep the AUM small.

Should you avoid schemes with low AUM?

While this is not a generalized argument, some financial advisors say that schemes with low AUM should be avoided because of two reasons –

1. These schemes have not yet reached critical mass for them to show consistent performance. In my opinion, critical mass is ₹1,000 in assets. I find this to be an important consideration in case of SIP as we are looking for long-term stability and the ability of the fund manager to ride the highs & lows of the market.
2. Opting for a low AUM scheme means you are paying more towards expenses as compared to high AUM schemes. Let’s see if this is true.

The data above shows that large cap equity mutual funds whose AUM is less than ₹700 crores have an expense ratio of 2.57%. And mutual funds with AUM of over ₹10,000 crores have an expense ratio of 2.07%. This is an extra 0.50% saving over the sub-₹700 crore AUM funds. This extra 0.50% goes as additional returns to you (the investor).

What is an extra 0.5% returns in mutual funds worth?

A lot. Say, you are investing ₹10,000 every month in an SIP for the next 20 years. This plan will yield you ₹99,91,479 at the end of the 20th year. This calculation has been done on a CAGR of 12%.

Now, if this number were 12.5% (that additional 0.5% from expense saving added in), your 20 year return would be higher. The final wealth corpus will be ₹1,06,95,196. That’s an additional ₹7 lacs you can earn by choosing an SIP based on AUM (and expense ratio)

Mutual funds with an AUM of between ₹700 crores and ₹10,000 crores have an expense ratio of 2.13%. This expense ratio is not very far from the 2.07% that large AUM funds charge. Thus, there is a good case for looking at funds thats are over the ₹700 crore AUM mark.

4. Actively managed funds v/s Index funds

This is a far more important consideration than what people estimate it to be. Infact 95% of the investors ignore or never consider this tradeoff between actively managed and index funds. The reason for this is similar to what we have seen earlier –

a) Mutual fund companies don’t have an incentive on promoting index funds as they have very low expense ratios.

Expense ratios are as low as 0.10% as in the case of HDFC Index Fund Nifty50 Plan – Direct Plan. On the other hand, fund houses charge anywhere from 1.20% to 2.20% for actively managed funds. This expense structure is even true in the direct plan category. For example, HDFC Top 100 Fund – Direct Plan, which competes with the HDFC Index Fund, has an expense ratio of 1.50%.

b) Distributors don’t have an incentive on promoting index funds as they make very low commissions from these funds.

The result of these is that the index fund in india is an ignored category.

• HDFC Index Fund Nifty50 Plan
  • Launched in year 2002
  • AUM : ₹563 crores
• HDFC Top 100 Fund
  • Launched in year 1996
  • AUM : ₹15,162 crores

Performance of an active and index fund of the same fund house

Now, let’s look at the performance of these funds –

• HDFC Index Fund Nifty50 Plan – 12.52% (since launch)
• HDFC Top 100 Fund – 13.79% (since launch)

I was expecting the HDFC Top 100 Fund to have a better alpha than +1.27%. That’s because the actively managed Top 100 Fund has much more opportunities to deliver superior returns when compared to the passive index funds. Some techniques that active funds employ are –

• The actively managed fund has a play with 100 companies as against the index which has only 50 companies. This allows some mid-cap companies (sometimes) where the return is generally higher over the long run.
• The actively managed fund can choose which of the top 100 companies they want in their portfolio. However, the index fund needs to have all 50 companies in their portfolio
• The actively managed fund can define the proportion of assets they want to spread across specific companies in their portfolio. On the contrary, the index fund has a defined formula of stock participation.

Lowering performance gap between Actively managed funds and Passively managed index funds

Over the last year or so, the difference between the performance of an actively managed fund and a passive index fund has come down. In 2008, the performance gap was 6.5% but in 2018, the gap was as low as 0.4%.

The difference is more visible in the United States. In the US, for many decades, less than 25% of the active funds have performed better than passive index funds.

All right. So what’s the learning for us?

Since SIP are instruments of long-term investing, we have to carefully examine and consider the efficacy of having actively managed and/or passively managed index funds in our SIP portfolio. It is my view that one should have 25-30% your SIPs in index funds. These can be benchmarked on the Nifty 50 and Nifty Next 50.

My study has proven that it is perfectly possible to make high returns with index funds when we add an element of annual rebalancing and asset allocation

The balance 70-75% can be in actively managed funds.

The share of index funds in our portfolio will have to grow further in the next 5-6 years as they become mainstream.

5. Consider Direct funds over Regular Funds

A mutual fund direct plan is when you directly approach the mutual fund company and purchase units in a scheme thereby avoiding distribution expenses in the form of an agent’s fee which is in-built in a regular plan of a mutual fund. In other words, you pay more for regular plans as compared to direct plans which affects your returns.

For greater understanding of the difference between the direct and regular plans of mutual funds, do read my article with the same title.

Some advisors try to con consumers by using tricks aimed at proving that regular funds are cheaper than direct funds. They say that regular funds come at lower NAV. Or they say that the expense ratio difference is only in the first year.

Don’t fall for any of this!

You can lose tens of lacs of returns over 20-30 years if you persist with regular plans.

Be smart – go direct!

How to Calculate Your Mutual Fund Performance?

What is XIRR?

XIRR is a method of calculating returns on investments where multiple transactions of buy & sell are happening at different times.

XIRR (or Extended Internal Rate of Return) is the best measure to calculate your mutual fund returns. This measure is highly recommended for calculating a single rate of return on your SIPs as it manages the complexity of you investing at regular intervals and redeem units partially from time to time.

Let’s see how this works with an case study for you to solve.

Joseph starts an SIP with HDFC Balanced Advantage Fund in February 2018. He invests ₹3,000 on the 5th of every month.

After six regular instalments, Joseph had to redeem some units due to a medical emergency.

While Joseph tried to persist with systematic investing, he had to cancel his SIP in October of 2018.

However he continued to keep the remaining units, even after a second redemption.

His corpus is now valued at ₹12,500 on 31-December-2018.

What is the XIRR?

Option 1 – Calculate XIRR manually

The formula for calculating XIRR manually is –

Option 2 (preferred) – use Microsoft Excel’s XIRR formula

Oh. This manual calculation is so tough. (headache!)

Fortunately, MS Excel comes to the rescue with an in-built XIRR function.

This takes care of the complications of different time intervals and positive & negative cashflows.

Inputs from you will include the purchases, redemptions and the corresponding dates. And the final entry should be the present value of the investments.

Do note that for calculating XIRR, all purchases have been entered as a negative value.

Notice a minus sign has been affixed before the amount

Similarly, all redemptions are entered as positive value.

Additionally the current investment value has also been treated as a positive value. This way we are treating all purchases as money moving away from you (cashflow out) and all redemptions & present portfolio value are money moving towards you (cashflow in).

How is XIRR different from CAGR?

The difference between XIRR and CAGR comes to their treatment of multiple payments at multiple time periods.

The CAGR is a very simplistic view of calculating returns. CAGR measures the annual compounded growth rate of an asset over a number of years. For this purpose, it assumes that the asset was available at x in year 0 and is now available at y in year 10.

On the other hand, the XIRR is a more practical as it measures your returns over multiple payments you might make periodically. This is in-line with how you work with your SIP where you not only add a constant amount every month and also redeem units from time to time.

Let’s understand CAGR in more details.

What is CAGR?

CAGR is the abbreviated form to Compound Annual Growth Rate. It is the rate at which an investment has grown over a period of time. The CAGR is expressed on an annual basis. This metric is a popular measurement to track the business performance, a company’s stock prices, profits, a nation’s GDP, population growth etc.

Calculating the CAGR is quite simple.

The formula for calculation of CAGR is –

OK. Then let’s learn with an example.

In the year 1995, you invested ₹8,00,000 and bought a piece of land in the outskirts of Bangalore. As luck would have had it, you got a job in Singapore and made the Lion City your home for the next 20 years.

You are back to your beloved Bangalore (now called Bengaluru) in 2015. And to your unbound delight, find that that parcel of land you bought in 1995 now fetched a princely sum of ₹1,00,00,000.

What is the CAGR?

CAGR and XIRR both are servants of compounding.

You can imagine an XIRR as a summation of different CAGRs. I say so because every break in terms of a investment (i.e. purchase) or divestment (i.e. redemption) is treated as an independent chunk for purpose of calculating the CAGR.

XIRR then stitches together these different CAGRs to give us a unified and single measure of our returns.

As a investor always look to calculate the XIRR rather than the CAGR or the absolute returns.

Absolute returns are an incorrect indicator of performance

Let’s understand this with an example.

You purchase an asset (a 10 gram gold coin) worth ₹30,000 on 1st January 2019.

Due to excessive supply of gold, the price of gold decreased by 4% over the first quarter of the year.

As on 31st March 2019, the value of your 10 gram gold coin had reduced to ₹28,800.

This is seen as a 4% loss in value from the purchase date.

While one can argue that your losses are 4%. But since all performance (returns and losses) is viewed on an annualised basis, we have to recalculate performance on an annual basis.

Since we have lost 4% in 3 month, this comes to a loss of 16% over a 12 month period. 4% vs 16% is a quite a large difference. And that’s why it is important to look at mutual fund performance on an annualized basis and not on an absolute basis.

Here is another example.

Real estate winnings look very thin on a CAGR basis

A recent advertisement in the newspaper by a real estate developed bragged about how their Gurgaon housing project had tripled in value for their first investors.

A friend is one of those beneficiaries. However since he is aware of the concept of annualised returns, he isn’t really bragging about it because this 1x to 3x value appreciation has taken 13 years.

Our math shows that the actual CAGR on this investment is only 8.82%. This is not any higher than what he would have made in a bank fixed deposit over the last 13 years. In comparison to a diversified equity mutual fund, the wealth generated from real estate is far lower.

Now that you have learnt about CAGR and XIRR, I won’t blame you for being greedy. Afterall everyone wants to invest in the best SIPs which can grow your wealth exponentially. Do read more of the blog articles to get an understanding of advanced wealth creation strategies that you can put to good effect.

How to Start a Systematic Investment Plan (SIP)?

Starting an SIP requires an understanding of five important areas –

1. Identify the Right Online Mutual Fund Investing App or Website
2. How to complete your KYC online
3. Knowing what mistakes are avoidable when investing in SIP
4. Understand the different types of SIP available in India
5. Selecting the best SIP for achieving your goals

Post your understanding of the above five areas – go ahead and download one of the many investing apps to start the process. Happy investing!

How to Manage Your SIPs?

There are four steps to managing your SIPs in the right manner.

1. Keep track of your SIPs
2. Review your SIP performance
3. Cancel or pause your SIP
4. Set up a one-time mandate

1. Keep track of your SIPs

It is common to see lethargy set in after setting up a systematic investment plan. This is largely because financial advisors and mutual fund houses project SIPs as the “fill it and forget it” solution to wealth building. This is not true and tracking your mutual fund SIP has many advantages.

The advantages of tracking your mutual fund SIP are:

• Tracking helps you know when the next instalment is due. This way you can ensure your bank account has enough monies when the due date arrives
• You can better understand which funds are performing well and which ones are struggling to meet the benchmark. The struggling ones can be replaced with better performing funds or the type of funds that meets your criteria
• Keeping track of your SIPs helps you during redemptions. This way you will be more informed of the exit load and the taxation impact due to the redemption. Exit load and taxes reduce your returns if you are not careful about managing that.
• Your allocation can be adjusted at defined intervals if you keep track of your SIPs. In this context, it is important to keep track of not only the schemes where you have invested your money but also the category of fund (like equity large cap, equity mid cap, balanced, debt etc.)

I use the ETMONEY app (mobile application) and ValueResearchOnline (website) for tracking purposes. These are well established web properties and they automate the tracking process.

2. Check & review your SIP performance

An SIP performance review should be holistic in nature and not be restricted to just the performance.

Here are some factors that you need to check for in regards to SIP performance:

• Fund composition – It is possible that the underlying mutual fund scheme has changed its outlook. As a result, the fund might have allocated more to debt or has more assets in small cap rather than large cap funds etc. These movements might have an impact on your desired asset allocation. Further, this will directly affect your mutual fund portfolio risk and is something you might want to review.

• Performance (returns) – Performance is always relative and should be checked against the category average and the performance of the benchmark. For example – the SBI Magnum Midcap Fund was very popular investors and distributors in the year 2013, 2014 and 2015. Since then, the fund has struggled to keep pace with other midcap schemes. The fund is 6% lower than the category average and the benchmark (S&P BSE 150 MidCap TRI). This should be a flag in your review.

• Performance (statistical measures) – The statistics surrounding the SBI Magnum Midcap Fund have also not kept pace with the category and benchmark. The Sharpe ratio and Sortino of the fund is way below the category and benchmark. This indicates that this fund is a high-risk fund when there are much better alternatives available.

How to evaluate the risks in a mutual fund

The risk measures that can help you arrive at better funds to select from over 1,000 schemes are your disposal are –

1. Alpha
2. Beta
3. R-Squared
4. Standard Deviation
5. Sharpe Ratio

• Fund Portfolio – A closer look at the SBI Magnum Midcap Fund portfolio reveals that over 5% of the assets of this fund are with two entities i.e. Sheela Foam and Cholamandalam Investment & Finance Co. Further, the fund has a high number of high PE stocks in it’s portfolio. Having a number of high PE stocks (per my definition, a PE of 35 or more) indicates that the fun is a growth fund. This approach is different from the one employed by some other midcap stocks. Like the ICICI Prudential Midcap Fund which operates at a much lower PE of 13 with a value orientation. There is nothing right or wrong about this but should have a bearing on your SIP management strategy

How often should you check your SIP performance?

You should check your SIP performance once in 6 months for the purpose of rebalancing your portfolio. And never make any drastic changes without having given your SIP fund a full 24 months.

This is important for two reasons:

1. equities are high risk category and it takes 24 months to accurately evaluate the performance of the fund relative to its benchmark & category
2. minimize the impact of taxation and exit load.

3. Cancel or pause your SIP

Your SIP is customizable to the extent that you can chose the type (growth or dividend), tenure (1 year, 2 years, 4 years and so on), amount etc. But few people know that SIP can be paused and even cancelled per your wishes.

Pausing SIP

The pause feature is offered by most mutual fund companies for their schemes. You can pause the SIP online which is far convenient that writing a letter or filling a form. Within a few days of that request your next SIP shall be paused. In effect, your fund house is instructing it’s system not to send the mandate to your bank to deduct the SIP instalment. Fund houses offer upto 6 months of pausing. You can use this solution than not keeping sufficient funds in your bank account. That’s because banks will charge you for the mandate not going through (like a cheque dishonour fee).

Cancelling SIP

You can also cancel your SIP. This can be done online in the AMC or distributor website/app. Alternatively you can fill & send an SIP stoppage form to the RTA office (CAMS or Karvy) or to the asset management company. The cancellation option should be used when your finances are stretched. You are always welcome to start a new SIP when your situation improves.

4. Setup a one time mandate

Automating your payments towards your SIP is a very effective way of managing your SIPs. There are three ways to pay money to a mutual fund for an SIP transaction –

1. Cheque – You will have to give one cheque for every SIP transaction. So when opting for a monthly SIP for 5 years, that’s 60 cheque leaves you need to deposit (not very efficient)
2. Biller Pay – Submitting an online SIP (generally in the mutual fund website) against which the mutual fund company will send you a unique biller code via email or SMS. Then log onto your net banking account and register the biller via the billers module.
3. One Time Mandate – OTM is an authorization to the bank to deduct monies from your bank account automatically. This happens whenever the mutual fund company presents a feed asking for money. Online distributors have built a layer on top of this where they use the OTM enabling investors to make payments across different mutual fund companies in lumpsum or SIP mode. This is more efficient than the above two points
4. E-Mandate – Works a lot like the OTM where one rupee is deducted from your bank account via net banking as a verification amount. Once confirmed, the SIP is deducted automatically from the bank account and deposited with the mutual fund company. E-Mandates are still a work in progress but are moving ahead at good pace as more banks come on board.

Are SIP safe to invest in?

“Safe” is generally referred in the context of not losing one’s principal. From that perspective, SIP is not a safe instrument because the underlying mutual fund is not a safe instrument. Let’s understand in more details.

Are mutual funds safe?

No. No mutual fund is safe.

And neither are banks and government of India bonds because banks and governments can fail and take down the principal invested. Recently the PMC bank scam was exposed which lead to a crisis in banking in the country.

Mutual funds are of different kinds and there are different levels of safety.

A liquid fund is one of the safest instruments out there so an SIP in liquid funds is relatively safe.

I use the word “safe” with some caution because liquid funds too will have days when the fund makes a loss due to some drastic changes in interest rates or credit risk etc.

Let’s observe the performance of Union Liquid Fund.

Even liquid funds are not principal protected

• The Union Liquid Fund has been in existence for over 7 years
• In this period has been giving a consistent, “safe” and steady return averaging over the category performance
• However it had a ₹99 crore exposure in IL&FS which wiped out an entire year’s gains when the fund house had to mark down in September 2018.
• The fund lost about 4% marking the worst period of performance due to this external factor.

Such episodes can lead to losses and are few in between, liquid funds are structured in a manner to provide a very safe haven for your investments.

On the other hand, equity funds are far from safe instruments.

Equity funds can have wild swings where in some years, one can have returns of upto 70% and in other years can lose upto 50% in value. While these are massive swings and often happen once in a decade, there is anyways enough volatility in the equity markets to shake any investor’s foundations. If safety is the primary concern for you, then equities will not be the right fit.

A ship is safest at the harbour but that is not where it is supposed to be

Anonymous

When do SIPs become safe-ish?

Yes, SIPs and investment in mutual funds do become safe-ish at some point.

Ofcourse, there is always the possibility of a black swan event like a war, famine, political or economic environment which might through the entire financial system into a tailspin or abyss. But under general conditions, we have seen that the longer investors stay in the equity markets, the more protected is your principal.

BSE Sensex Rolling Returns

In response to the above question, I looked at the BSE Sensex returns data from 1979. 1979 is the inception year (also called the base year).

The examination of returns was on a rolling year basis wherein I measure the annualized returns of the BSE Sensex every year, every 3 years, every 5 years, every 7 years, 10 years, 15 years and 20 years.

Let me illustrate on the basis of the chart below.   

The calculation of rolling returns is quite simple.

For example – you want to calculate the 5-year rolling returns of 2016. For this, you need to have just two data points – a) the closing price of the Sensex on 31-Dec-2016 and b) the closing price of the Sensex exactly 5 years ago i.e. 31-Dec-2011

As per our Sensex data –

• Closing value of Sensex on 31-Dec-2016 : 26,626 points
• Closing value of Sensex on 31-Dec-2011 : 15,455 points

Now, we need to calculate the CAGR which can be done using the formulae –

• CAGR = [(Closing value 2016 / Closing value 2011) ^ (1/5)] – 1
• = [(26,626 / 15,455) ^ (1/5)] – 1
• = [1.7228 ^ (1/5)] – 1
• CAGR = 1.1149 – 1 = 0.1149
• CAGR % = 11.49% (rounded to 11.5%)

Importance of Rolling Returns in determining safety of SIPs

Investing is a long-term exercise and the longer you participate in the equity markets the better is your chance of absorbing any and all losses.

As seen in the chart above, I broke the entire duration of the BSE Sensex different tenures of 1 year, 3 years, 5 years, 10 years, 15 years and 20 years.

The idea here is to see at which tenure we can be assured that the probability of capital loss is the least.

The Sensex historical data shows that the Sensex has never given a negative return over a ten-year period. It is hence advisable to continue your SIP program for a period of 10 years.

A second area to understand is the variability of the returns.

Variability of returns over multiple periods of time

One year returns will be a lot more volatile as compared to longer tenure returns. This can be seen in the image below where I have plotted the 1 year and the 10 year rolling returns.

Additionally, we see that the range of one-year returns can be huge. In 2008, the Sensex dropped by 52.4% and just an year later (2009), returned a positive 81.0%. This is a swing of 133.4%.

When we compare this with the ten-year rolling returns, the lower end of the band is at 2.6% while the highest band is 30.6% — a much narrower range of 28.0%

The data thus concludes that having a ten year outlook on the equity markets will help you whether storms. It will also give you a certain predictability of how much returns can you make over the ten year period.

SIP Calculator

Planning is the first step to success. Use the SIP calculator below to plan how much wealth you can accumulate when following a systematic investment plan.

The following inputs are required to calculate your final corpus using the SIP calculator:

1. Monthly investment – How much money you want to invest every month?
2. Interest rate* – What is the expected annual rate of return?
3. Interest compounding** – How often will your money turn over?
4. Period (months) – How many months you expect to continue your investments?

* The expected rate of return depends on the kind of asset class in which you are setting up your SIP.

Return estimates for each type of mutual fund

Here is the estimate I take for different asset classes –

• Liquid funds – 6% per annum
• Debt funds – 7% per annum
• Large cap funds – 12% per annum
• Multi-cap funds – 14% per annum
• Mid and small cap funds – 15% per annum
• Value funds – 14% per annum
• Hybrid Aggressive funds – 11%

With these estimates, you would have seen that I am more conservative than other financial advisors. The reason for this is that I am looking at these SIPs over the coming 10-20 year period and not on the basis of current performance numbers.

For example, multi-cap funds have averaged returns of 16.88% over the last 10 years. But over the long-run, as markets become more efficient, the returns will shrink and stabilize for a developing-to-developed country like India.

If you really want to geek out, here is the comparison between my next 10 year estimates and what the last 10 years have yielded for different types of funds.

** Since all the returns we have in this blog post are annual in nature, I recommend you change the compounding to “Annual”

Smart Tactics Used to Improve SIP Performance (and Lower Risk)

1. Target Investment Plan

An SIP works on the principle of investing a uniform amount over a period of time. Against this uniform amount invested, the mutual fund company issues units which may be more (if the NAV dips) or less (if the NAV increases) in any month.

A TIP (target investment plan) works on a principle similar to SIP with one major difference – the number of units remains uniform while the amount invested keeps on differing each month.

The concept here is that when the markets are expensive, you invest less money; and when the markets are cheap, then you expend a higher amount of investment money.

Users who have specified goals will have a preference for the TIP over SIP. In other words, the primary disadvantage of SIP is that there is a lingering uncertainty with regards to achieving goals over the long-term as the final corpus amount is unclear.

Difference between SIP and TIP

2. Use SIPs to invest in Equities. Use Lumpsum to Invest in Debt.

This is the smart way of investing.

Unless there is blood on the street, smart investors put money into the stock markets in the SIP mode only.

Blood on the street is my way of saying equity markets have crashed on account of unwarranted fear among investors.

This is a classic risk avoidance strategy which saves you from any ill-timed movements into the equity market. Amateur or beginner investor are guilty of putting in a big wad of money into equities only to see the market tank in a couple of months. Move ahead steadily and be opportunist only when there is an opportunity.

Investments in debt can be managed best using the lumpsum mode. This can be the case when you receive a windfall like your annual appraisal bonus or insurance policy maturity. It is prudent to invest the same in debt funds of your choice.

If you are keen on equities, then setup a Systematic Withdrawal Plan (SWP) from your debt fund investment for movement into equities which can happen periodically. This way you have an effective risk avoidance strategy and you get the desired asset allocation

3. Beginners Opt for Balanced Funds over Other Options

This is easier said than done.

Beginners find it difficult to understand the return and risk matrix and pick mutual funds on a descending order of sort.

Recent data shows that when no filters are applied, investors were simply doing a descending order sort by returns and choosing funds that come on the top.

It worries me more when investors buy sectoral funds using these ill-informed techniques. These sectoral mutual funds come with extremely high risk and volatility.

In a known case, many investors invested in the Tata Mutual Fund’s Digital India Fund. A number of them lost 13% of it’s value in just 1.5 months leaving a number of aggrieved investors.

• NAV on 3-Sep-2018 : 16.29
• NAV on 26-Oct-2018 : 14.19
• Absolute loss to investor : 13.0%
• Annualized loss to investor : 61.3%

Balanced funds are highly recommended for beginners as they embark on the mutual fund and SIP journey.

Balanced funds (or Hybrid Aggressive Funds) have about 65% invested in equities and the rest 35% in held in debt. This gives a cushion to investors against any volatile movement in the equity markets.

4. Restrict to 7 schemes

Some investors do go really overboard with dozens of SIPs, each of small amounts. This is over-diversification which does not bestow any advantage to the investor because the portfolio starts resembling a generic index fund.

You really don’t need more than 7 funds in your portfolio’s SIP stack. Your can setup SIPs in the following manner –

1. Hybrid Aggressive Fund (when you start investing)
2. Multicap Fund or Large & Midcap Fund
3. Midcap Fund
4. Value Oriented Fund
5. Multicap Fund or Large & Midcap Fund
6. Smallcap Fund
7. Value Oriented Fund

How to diversify SIPs smartly?

My selection of those 7 funds will have:

• Multicap or Large & Midcap funds – 2
• Value funds – 2
• Midcap fund – 1
• Smallcap fund – 1
• Hybrid Aggressive fund – 1

The logic behind this composition is as follows –

• Multicap and Large & Midcap funds has a good proportion of India’s Top 100 companies. These companies are generally industry leaders with strong business models. With two funds apportioned to mid-to-large companies – our portfolio gets a lot of stability with a stronger ability to withstand economic shocks
• I recommend the presence of two value-oriented funds. These provide a powerful effective contrast to the multicap funds. Value funds rely on picking stocks on the basis of their fundamentals and are not swayed by growth or hot industries or sectors. Value funds in the portfolio will give the necessary diversification with presence of sectors which the growth funds ignore.
• A Midcap fund and a smallcap fund helps you get the necessary boost in returns over the long term. Midcap funds have performed at a CAGR of 21.09% while smallcap funds have performed equally well at a CAGR of 19.81%. Compared to these, the multicap and large & midcap funds average 16.80%. There is a potential 3-4% alpha by having the midcap and smallcap funds in your portfolio. However given the volatile nature of these funds, I have restricted it to only one fund each
• A hybrid aggressive fund (previously called a balanced fund) is a good starting point for beginners. This will ease you into the world of investing and will provide good cushion and strong returns. The equity portion of these funds are more multicap-to-largecap in nature as they try to provide stability to the portfolio. These funds generally avoid smallcap funds & don’t have much of midcaps in their portfolio.

Backtesting with an example

I pushed my research further to see how my portfolio might look if I have 2 multicap funds, 2 value funds, 1 midcap, 1 smallcap and 1 hybrid aggressive fund in my portfolio. For this purpose, I have chosen the following funds as they have high AUM in their respective categories –

• Multicap – Kotak Standard Multicap Fund (Direct plan)
• Value – ICICI Prudential Value Discovery Fund (Direct plan)
• Midcap – Franklin India Prima Fund (Direct plan)
• Small cap – HDFC Small Cap Fund (Direct plan)
• Hybrid Aggressive – SBI Equity Hybrid Fund (Direct plan)

A review of the table above shows how having a planned approach to your SIPs will give you a well-rounded portfolio that is diversified in terms of returns, risk and strategy.

• The portfolio is not concentrated in financial stocks as value funds and smallcap funds do bottom-up stock picking
• While the multicap and value funds will provide stability with large and mid-to-large companies in their portfolio, the midcap and smallcap funds help you participate beyond the top 200 companies.
• The last five years have been good for Indian equities and that’s why you see the growth funds doing better than value funds. However as markets get expensive, growth stocks start lagging in performance and the value stocks do extremely well. This means your portfolio is now protected to drastic downturn in returns as the value funds will cushion the dips.

Conclusion

They say, you swing a racket a thousand times every day for a thousand days and you’ll probably have had enough practice to beat Roger Federer. Well, an SIP of a similar magnitude can make you a GOAT investor. It’s true! Because investing ₹1,000 for 1,000 months at 15% per annum gives you a total corpus of ₹987,34,40,298 (almost ₹1,000 crores)

SIP is a system designed to serve retail investors like you and me. It is a disciplined effort where the effort part is overstated. And that’s because financial institutions and fintechs have made it very easy for you to invest in these mutual fund instruments in the SIP mode. Investing is easy, managing is easy and redemption too is easy (we’ll learn about instant redemption in a later blog)

A journey of a thousand miles must start with one small step

Lao Tzu