Long-term investors should retain their faith in equities and not reduce or stop their equity mutual funds through SIPs, advises Jason Monteiro.
Illustration: Uttam Ghosh/Rediff.com
Investing in equity mutual funds through systematic investment plans (SIPs) has gained popularity among retail investors over the past couple of years.
Despite the volatility in the markets during the current financial year, mutual funds have added about 10.05 lakh SIPs each month, on an average.
Monthly inflows through SIPs, in fact, hit an all-time high of Rs 79.85 billion in October 2018.
SIPs work on the principle of rupee-cost averaging.
By investing a fixed amount every month, investors are able to buy more units when the net asset value (NAV) of the fund falls, and fewer units when the NAV rises, thereby averaging out their cost of purchase.
However, equity investments made through the SIP route can also be volatile.
The biggest mistake that investors can make when SIP returns turn negative is to stop their monthly investments.
Near-term returns have turned negative
Investors who began investing through the SIP route over the past one year are a disappointed lot today as returns have turned negative.
For large-cap funds, the SIP return over the one-year period (ending on November 1, 2018, valuation date November 22, 2018) ranges from -1.29% to -21.04%.
For mid-cap funds, the SIP return over the same period ranges from -3.81% to -24.89%.
Investors should keep in mind that returns over shorter time frames often tend to be volatile.
When investing in equity funds, investors should not get excessively swayed by one-year returns.
The last time the one-year SIP based on the S&P BSE Sensex turned negative was in April 2016.
On the brighter side, over the past two decades, one-year SIPs were positive on 174 occasions out of 240 monthly observances.
In other words, one-year SIPs have been positive 72% of the times.
Hence, periods when SIPs delivered negative returns have usually been short-lived.
Over the same period, returns through a three-year SIP based on the Sensex were negative on just 13 per cent occasions.
For five-year SIPs, the returns were negative on just 8% of the total periods over the past two decades (this analysis is based on October 31, 2018 valuation).
Thus, in equity investing, the longer you invest for, the better.
So, do not worry about the short-term underperformance of your funds.
Long-term returns remain sound
For investors looking to create a corpus, say, for their child's higher education, or for their own retirement, one-year underperformance is a mere blip.
What matters is the return they are able to earn over the long term.
And those numbers appear quite decent for Indian equity funds even today.
Over a 10-year period (last SIP date November 1, 2018, valuation as on November 22, 2018), large-cap equity funds have generated SIP returns that ranged from 7.61% to 14.26%.
The median SIP return was 11.18 per cent.
For midcap funds, the 10-year return ranged from 9.50% to 19.11%.
The median figure was 16.17%.
These are quite robust numbers.
An investor who ran an SIP of Rs 1,000 over this 10-year period in a large-cap fund would have ended up with a corpus of around Rs 215,000 (using the median rate of return) while someone investing in a midcap fund would have ended up with a corpus of Rs 292,000.
Thus, investors with a long investment horizon would have been suitably rewarded.
Small-cap funds have generated the largest losses for investors.
Over the past year, while the benchmark S&P BSE Sensex has gained 4.23%, the S&P BSE Mid Cap Index has lost 11.35% and the S&P BSE Small Cap Index has declined 19.62%.
The deviation in returns across mutual fund categories teaches an important lesson on diversification.
Investors often chase returns.
A year ago, small-cap funds were generating heavily positive returns.
However, over the past one year, the NAVs of these funds have fallen by over 20%.
Large-cap funds have been relatively more resilient over the past 12 months.
Thus, even if you are investing via an SIP, it is essential to diversify your portfolio across large-cap, multi-cap, mid-cap and small-cap funds to be able to cope with downturns better.
When SIP returns turn negative
When investment returns turn negative, they affect investors sentiments. They tend to turn cautious and limit their investments.
Long-term investors in particular should retain their faith in equities and not get persuaded into reducing or stopping their equity mutual funds through SIPs.
Remember, SIPs help you average out your cost.
Hence, if the average purchase NAV of your mutual fund scheme is lower than the NAV at the time of valuation, you would have generated positive returns.
However, if the reverse happens, where the average purchase NAV is greater than the current NAV, the returns would be negative.
The key to earning positive returns through SIPs is to keep the investments going when the market underperforms.
That is the best way to reduce your average NAV.
When the markets turn around, that is when the true advantage of continuing with your SIPs during market downturns will be realised.
The reason most investments via SIPs have turned negative over the past year is that they came in at a higher price between May and September 2018.
The average price was rising over this period. The sharp correction since September has resulted in negative SIP value.
Thus, until and unless the NAV of the fund moves above the average purchase price of your investments, your SIPs may continue to be in the red.
Do not get bogged down by this short-term underperformance and maintain a long-term view of the market.
Such corrections are common and are the best time to average out your costs.
So, stay invested and continue your SIPs.
Investing via SIPs in mid cap and small cap funds, which have declined more, may prove beneficial for the long term.
If you are not sure about which actively managed mutual funds to select from the many available, you may invest via an SIP in an index fund.
Jason Monteiro is assistant vice president, mutual fund research and content, Prabhudas Lilladher.