There are 248 trading days in a year. With SIPs, you just invest on 12 out of those 248. If the purpose is cost averaging, then why invest just 12 times in a year? Why not every week, or for that matter why not every day? Also SIP is after all just an entry strategy. It governs when to invest. But what about exit? If your investment plan is premised only on SIPs and doesn’t have an exit strategy, it’s akin to a “Chakravyuh” – you know how to get in, but don’t know how to get out!
By Indranil Guha, Co-founder – Finpeg.com
SIPs have clearly emerged as the most popular way of investing in equity mutual funds amongst retail investors. At the last count, monthly flows into mutual funds through SIPs alone had topped a staggering Rs. 5,000 crores per month, sharply up from Rs. 1,400 – 1,500 crores per month till as recently as 2014.
And there’re good reasons why SIPs have gained in popularity. To begin with, SIPs are great for cost averaging. When you invest a fixed sum at fixed intervals, you get to buy across all market conditions – rally, correction as well as flat markets. Over time, this helps you achieve a very good average buying price. And such averaging is now universally acknowledged as a proven risk reduction strategy.
Furthermore, SIPs are a great way to beat basic human instincts of greed and fear while investing. A SIP based investing approach helps instill a disciplined approach to investing. By investing a fixed sum at regular intervals, without bothering about prevailing market conditions, you can avoid the pitfalls of potentially becoming greedy and thus “over-buy” when the markets are rallying strongly, or for that matter becoming fearful and thus “under-buy”, or still worse sell when the markets are correcting sharply.
Limitation 1 of SIPs – Inadequate Averaging
To achieve the above, most SIP investors have come to adopt what is essentially a monthly SIP approach, wherein they invest a fixed sum in one or more mutual fund/s on a fixed date every month (typically at the beginning of every month). However, in a monthly SIP approach, you invest only 12 times in a year. Barring weekends and holidays, there are typically 248 trading days in a year. If the purpose is cost averaging, then why invest just 12 times in a year? Why not every week, or for that matter why not every day? Indeed, the best possible cost averaging can be achieved when you invest on every trading day of the year, isn’t it?
Limitation 2 of SIPs – What about Exit Strategy?
Also, if you think about it, SIP is but an entry strategy. It governs when to invest. But what about exit? When should you redeem your investments? If your investment strategy is premised only on SIPs and you do NOT have an exit strategy, then your investment plan is incomplete. An investment plan without an exit strategy is akin to getting into a “Chakravyuh” – you know how to get in, but don’t know how to get out! That’s how critical an exit strategy is. But what are the traits of an optimal exit strategy afterall? At Finpeg, our statistical analysis of historical performance of high performing mutual funds across market cycles suggests that the principles of cost averaging through a staggered entry strategy involving high frequency SIP investments over a period of time are just as applicable, when it comes to an exit strategy. So just as a staggered entry strategy involving high frequency SIP investments can help achieve a very good average purchase price, a staggered exit strategy involving high frequency redemptions over a period of time can help achieve a very good average selling price. So our recommendation is to adopt an SIP-based entry strategy based on high frequency (weekly, if possible daily) investments over a period of time, and couple that with an exit strategy, also based on high frequency redemptions over a period of time.
Risk Compression – The art of killing risk
In fact at Finpeg, our analysis of historical performance of high performing mutual funds strongly confirms that a staggered entry strategy based on high frequency investments coupled with a staggered exit strategy based on high frequency redemptions helps bring down the standard deviation (or risk) associated with investments in equity mutual funds to extremely low levels.
Consider this equity mutual fund called ICICI Value Discovery Fund. Thanks to its stellar performance across market cycles, this fund has now acquired cult status amongst its investors. Average 1-year returns of this fund between 2006 and 2017 has been 25% with a Standard Deviation of 43%. What does that mean? It simply means that if you invest in this fund today and redeem after one year, there’s a 95% probability your return will be in between (25% – 2 x 43%) and (25% + 2 x 43%) i.e. between -61% and +111%. Now this just confirms what most seasoned equity investors already know – that equity investments can be highly volatile in the short term. Your returns could be as bad as -61% or as stellar as +111%. So how do you mitigate such high volatility? Simple, go long term. Average 3-year returns of the same fund has been 21% per annum with a Standard Deviation of 11%. This means that if you invest in this fund today and redeem after three years, there’s a 95% probability your return will be in between (21% – 2 x 11%) and (21% + 2 x 11%) i.e. between -1% and +43%. Now that’s a far more comfortable range, because the risk of negative returns is now largely eliminated.
The good news is you can do still better. At Finpeg, our historical back testing of the fund’s performance since 2006 shows that a staggered entry strategy based on high frequency investments in this fund, coupled with a staggered exit strategy based on high frequency redemptions from this fund over a period of time can potentially help achieve 20%+ return, but this time with a standard deviation as low as 2.81%. This means there’s a 95% probability your return could be in between (20% – 2 x 2.81%) and (20% + 2 x 2.81%) i.e. between +14.3% and +25.6%. Lower end of the return range at 14.3%! Now that’s something right? That’s the power of combining a high frequency investment strategy with one involving high frequency redemptions.
How to bring this to work?
Now executing this strategy can be quite cumbersome. There’s no known AMC or third party platform at this point in time that offers a facility to invest with a daily or weekly frequency in mutual funds, and it’s simply infeasible to invest daily or weekly in your preferred fund/s manually. This is where Finpeg can come in handy. Finpeg is arguably the first and only platform in India that offers retail investors an automated approach to set up custom investment and redemption plans with any frequency they like.
You can set up investments (or redemptions) in (or from) any mutual fund on every trading day of the year. Or you can set up investments (or redemptions) on, say the 1st, 6th, 19th, 23rd and 28th of every month, or you could set up investments (or redemptions) on every Monday and Wednesday of every week. Or you could simply set up an investment plan as per our proprietary strategy, involving high frequency investments over a period of time, coupled with high frequency redemptions over a period of time, and achieve the kind of phenomenal compression in standard deviation (i.e. risks) associated with your equity investments I have talked about above. Just sign up on Finpeg and we will help you set up an optimal and comprehensive investment plan for you that combines the above entry and exit strategies.
DISCLAIMER: Mutual Fund investments are subject to market risks. All projections above are based on past performance of scheme(s) between April 2006 and March 2017. However past performance of scheme(s) do NOT indicate assurance of comparable performance in future. Hence any projection above should NOT be construed as an assurance or guarantee that the objectives of the recommendations will be achieved. Please read all scheme related documents carefully before investing.