Compounding investors’ wealth -SIP

Compounding investors’ wealth - SYSTEMATIC INVESTMENT PLANS

MUCH has been said about taking a systematic approach to investing. Most investors appreciate the need to save systematically, but forget to actually do so in the hurry-scurry of life and work. Only a wise and disciplined investor takes the trouble to build a reserve. We fret more readily about buying the right model of television, or a washing machine at the right price, than we do about our long-term financial wellbeing. Result: we are vulnerable to difficulties later on in life, and realise too late that saving in advance would have eliminated or reduced our pain. Lay investors do understand that their wealth generation potential is at its peak from the age of 25 to 45 years, and starts dropping as they approach retirement. A cardinal sin of investing that many investors make is not saving enough at a young age, and waiting too long to build a nest egg. Things may look chipper in terms of career and health when you’re young, but they may not stay that way. As you grow older, health risks increase. Changing business dynamics may slow your career’s progress. Even if you’re lucky to avoid those problems, you’d still need to plan for life events like your children’s education and marriage, and your retirement. This requires long-term planning and saving. So there is really little choice for investors besides systematic investing. All mutual funds offer Systematic Investment Plans (SIPs). A SIP is a disciplined way of investing. It allows you to invest a pre-specified fixed amount of money at regular intervals, generally monthly or quarterly, in a mutual fund scheme. The money is invested at the thenprevailing Net Asset Value (NAV). Once you have picked a mutual fund scheme and the monthly investment amount, you can write out post dated cheques or instructions for an automatic debit from your bank account. So a SIP is a staggered form of investment. The systematic approach of SIPs ensures you attain your long-term financial goals, if you do disciplined investing from a young age. Generally, our investments seek to fulfil financial goals such as buying a house, marriage, children’s education, and so on. These entail a huge one-time outgo. Most of us cannot raise such amounts at short notice, and need to build the desired corpus over a long period. SIPs do exactly that. They cultivate a savings habit, just as a “Piggy Bank”does for a child. So SIPs can help us be disciplined investors. Ideally, one should start saving and investing early in life, but sometimes financial constraints prevent us from doing this, especially in the case of middle-class investors. SIPs enable investors with low investable surpluses to start with amounts as low as Rs 500 per month. They need not strain your monthly finances. SIPs work on the basic principle of compounding. As the saying goes, “Time in the market is more important than timing the market.” Long term investing through SIPs lets us realise the power of compounding, especially in equity schemes. Compounding increases the value of an investment exponentially over time. In other words, the interest earns interest. For example, compounding at the rate of 15% means your Rs 100 becomes Rs 115 at the end of year 1, on which another 15% is added. That makes it Rs 132.25 at the end of year 2, which is then reinvested at 15%, until maturity or redemption. As time passes, the money grows more rapidly, and in the opposite direction to inflation. Here’s an example to show how compounding makes money grow increasingly rapidly. Let’s say investor A starts investing Rs 1,000 per month from age 25, and investor B starts investing Rs 1,000 per month from age 30. We compound their investments at 15% per year, until each investor is 55. Investor A will get Rs 69,23,280, while investor B will get Rs 32,43,530. A mere difference of five years can lead to a wealth difference of over Rs 36 lakh—more than the entire sum investor B will receive. This is the beauty of compounding. How else do SIPs help investors? We all want to buy stocks when prices are low, and sell them at a higher price. But timing the market takes a great deal of resources, which retail investors lack. Systematic investing continues irrespective of market conditions, which makes for “rupee cost averaging”. When you’re investing the same amount at regular intervals, you buy more units when the NAV is down. Over time, this reduces the average purchase cost per unit. So SIPs can smoothe out ups and downs in equity markets, and protect you from volatility. Some investors are not convinced about SIPs, and prefer to invest as and when they think the markets are ripe. This works well sometimes, but can backfire badly. Recently, the BSE Sensex dropped 29% in only 9 trading sessions. If you had invested a big chunk of money just before the fall, you’d be sitting on a huge loss in your portfolios, and would take a long time to recover. SIPs invest in markets at all points of time, whether bullish or bearish. Investors tend to feel psychologically comfortable in a rising market, and scared during downturns. Many try to stop SIP investments when markets fall. This is totally contrary to the logic of systematic investment. Such investors are depriving themselves of the important benefit of rupee cost averaging. There’s no question of whether to invest through a SIP. Any investor who wants to create wealth in the long term should do so. Every household should have one or more SIPs running simultaneously towards the family’s future needs. Small amounts tucked away every month won’t pinch much, and they will provide you much-needed wealth in the long term.

Sameer Kamdar is Country Head, Mutual Funds, Mata Securities
Times of India, Mumbai 5th Feb 2008, Page 45