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SIPs vs active investing: Which is better?
Vinod K Sharma | April 05, 2008 10:49 IST
Systematic investment plan is a popular investment strategy employed by a large mass of investors. Instead of making one lumpsum investment, investors put in a fixed sum of money each month, over a period of time. This system does away with the need to time the market.
Mutual fund managers find the strategy easy to sell because they harp on the age-old truth that nobody can time the market. Secondly, it addresses a large spectrum of clients ranging from anybody who can spare Rs 500 each month to the richest person in the world.
But there is a way of earning better returns than the SIP. We will come to that part later, but first, let's understand the major features of the system.
SIP is only a methodology of investing. Investors must remember that merely investing through SIPs will not deliver the results. You need to choose the right scheme first. Money invested through a SIP will lose value if invested in the wrong scheme. So selection of the right scheme is the first job.
By opting to invest every month, you invest in a disciplined manner. This results in forced savings. As this is a monthly exercise, you tend to plan your expenditure and do not indulge in impulsive shopping.
Given an option, everyone would like to exit at the highest level and enter at the lowest. Unfortunately, no one has a crystal ball. So one can't really time the market. But it is possible to give better returns than through SIP or investing in a lumpsum. Here's how.
We turn the clock back and replay the current rally. It is May 1, 2003, the beginning of the rally. We give the SIP investor the benefit of hindsight and let him invest on May 1, 2003. Our SIP investor invests Rs 10,000 on the first of every month subsequently.
We save Rs 10,000 each month in our savings bank account. But we invest only 50 per cent of the amount saved if the Nifty falls 10 per cent from its high. If it falls another 10 per cent, we invest the rest. If, during the same month, the Nifty falls another 10 per cent, you have no money to invest and you have to let the opportunity pass as would happen to us in June 2006. You exit your positions only if you gain 50 per cent from the investment levels.
Here, our first opportunity to invest would have come only on January 22, 2004, when the Nifty finished 10 per cent lower from its January 9 high of 2,014. By then, we'd have accumulated Rs 90,000 in our savings bank account and invested 50 per cent of the money, that is, Rs 45,000 on January 23 in the Nifty. Though the low of Nifty on that day was 1,771, the actual closing was 1,847. And we have taken our investment at 1,847.
Over all, during this period, we would have been rewarded with 12 such opportunities of investing and nine opportunities of disinvesting.
How do the returns compare? We find that the SIP has resulted in 28 per cent annualised return against 39 per cent of the Nifty. The annualised returns through an active investment plan were 48 per cent. You invested Rs 10,000 every month in an SIP, that is, Rs 510,000 and made a profit of Rs 416,000 as on Thursday, April 3, 2008.
In our theoretical active scheme, you had to invest only Rs 130,000 and would have still made Rs 388,000. Not a bad deal, I think.