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Why SIP is the best investing style

By Amar Pandit
January 11, 2010 12:06 IST
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"Discipline is the bridge between goals and accomplishment." -- Jim Rohn, American speaker and author.

However while investing, we often seem to forget this. Our zeal to make quick money, even at utmost risk, leads to a lot of grief. While there are several theories of investing in the stock market, retail investors are better off by simply investing consistently.

Among the many mantras, market timing is the most common, where investors look to enter, book and exit quite often. There are also diehard followers of the buy and hold strategy. At the same time there are experts who would say that portfolio rebalancing across asset classes such as equity and debt is a must.

They believe since no one can time the markets consistently, there is no point in chasing this strategy. Then, there are proponents of the cost averaging theory, popularly known as systematic investment plan (SIP).

So, which is the best strategy to be followed? Let's try and answer this by looking at how each of these strategies have fared since the start of the global financial crisis.

We have taken four strategies and invested Rs 1 lakh (Rs 100,000) in each of the scenarios. The start date for each will be September 1, 2008, when the Sensex was at 14,498.51.

We have taken this date as this month saw the collapse of Lehman Brothers, widely considered the start of the market mania on its way downwards.

  • Buy-and-hold strategy (lump sum investment)

  • Market Timing with 50 per cent invested on 1st September 2008 , 30 per cent when the Sensex was at 10,000 (17/10/2008) and 20 per cent when the Sensex was at 8,200 (27/10/2008).

  • Portfolio Rebalancing every quarter to maintain an equity allocation of 60 per cent and debt allocation of 40 per cent (Debt generating a post-tax return of 6 per cent). We have taken quarterly rebalancing for this analysis.

  • SIP of Rs 20,000 every month for five months or Rs 10,000 every month for 10 months . This is also a buy and hold kind of strategy, except that investments are spread over a period of time.

    The results of this exercise would surprise many.

    Here we get an absolute return of 55.61 per cent. However, it is very unlikely that a market timer invested at 10,000 and 8,200, as there was so much pessimism going around that even very seasoned experts missed the rally till the Sensex was back over 15,000 levels.

    Most of the same experts missed it post 15,000 as well, as they believed the index was overvalued and should correct. Not just this, a lot of smart investors sold at 12,000 and then at 10,000 and further at 8,000 and did not get in till after election. Hence, I can confidently say that market timers or experts would have certainly fared worse than the buy and hold buyers.

    This strategy started with a Rs 60,000 allocation to equity and Rs 40,000 to debt. Then, every quarter the portfolio was rebalanced and the final value of investments at the end of December 31, 2009, was Rs 127,000. Thus, the absolute returns are 27.47 per cent.

    As on 31/12/2009, the total value of investments was Rs 174,473.45, a return of 74.47 per cent.

    SIP of Rs 10,000

    If one did an SIP of Rs 10,000 for 10 months, then on the last day of the year, the total value of investments was Rs 164,169.21, a return of 64.17 per cent.

    As you can see, SIPs score by a wide margin over the popular market timing wisdom. The only point is that if the market goes up continuously without taking a break, then a buy-and-hold strategy or lumpsum investment would score over most strategies, including the SIP route.

    Even when markets are at record lows, lumpsum investments will score over every other strategy. However, since the market is unlikely to move in a linear fashion all the time, rather, there would be constant crests and troughs, it makes more sense to have a disciplined approach to investing.

    Cost averaging is an added advantage. Remember that averaging a fundamentally bad investment will do no good and hence SIP should be used for fundamentally sound investments only (be it stocks, mutual funds , or gold).

    The writer is director, My Financial Advisor.

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