Most of us know Systematic Investment Plan (SIP) and its many benefits. SIPs emphasize discipline and consistency. Whatever your opinion on the market or the economy, through SIP, your money is regularly invested in the mutual fund.
The convenience aspect also plays a significant role. Investing is far less stressful and time-consuming because the entire process is automated.
A predetermined sum is deducted from your bank account and invested in the fund of your choice on a particular day every month. It does away with the common temptation to attempt timing the market, which is practically impossible.
When we talk about the importance of Systematic Investment Plans (SIP), SIP in equity mutual funds comes to mind. But SIP is a facility through which investors can invest in different mutual funds at a predetermined date.
A debt fund is a type of mutual fund that primarily invests in debt instruments. However, does it make sense to invest in debt funds through SIP?
We will look into this aspect in this article.
If you don’t have a lumpsum amount to invest in a debt fund
It is essential to remember that SIP is just a tool to invest in mutual funds every month. Many people may not start investing in mutual funds because of the lack of a sizeable lumpsum amount, say Rs.1 lakh or more. This is the gap that SIP aims to fulfil.
Going systematic would be ideal if you want to save money for a short-term goal or build an emergency fund in a debt fund but don't have enough money to invest in one go.
In this scenario, the main objective is to accumulate the amount you need and keep it safely until required.
SIP works better for equities
One of the key features of SIP is that it helps reduce the volatility of the mutual fund or make the best out of the volatility. Investing in mutual funds through SIP allows investors to get more fund units when the market is down. And when the markets rise, investors can generate higher returns than a lumpsum investment made at the beginning of the period.
Let us take an example to make it clearer. Mr. X and Mr. Y want to invest Rs. 10,000. While Mr. X made a lumpsum investment of Rs. 10,000 in January, Mr. Y invested Rs.5,000 in January and the rest in February.
Also, the unit price of the fund varies across the three months.
|NAV||Units Received by X||Units received by Y|
|Total fund units||500||750|
|Value of the investment at March End||30||15000||22500|
So, we can see the investment value of Y is higher than X. This is a very simple example, but we want to show here that when there is high volatility in the fund, staggering the investments instead of investing in one go can make a lot of difference.
However, debt funds are not volatile like equity funds. But debt funds that invest in longer maturity papers like gilt funds, long duration and dynamic bond funds are more volatile among debt funds as the performance of these funds depends on the changes in the interest rates. Currently, gilt funds are the worst performers in the one-year horizon.
Standard deviation helps us to understand the volatility of the fund. So, we compared the volatility of some types of mutual funds.
|Equity: Large Cap||21.05|
|Debt: Credit Risk||10.08|
|Equity: Small Cap||26.96|
Source: Value Research
We can see the vast difference in the volatility of equity and debt funds.
Barring exceptions like write-downs resulting from credit events, the times when the NAV of the fund is down is not very severe. As a result, the effect of this cost averaging is negligible.
Let us consider the worst one-year performance of Axis Gilt Fund and Axis Bluechip Fund.
As per Value Research, the worst one-year performance of the fund was -3.95, and it took place between 20th May 2013 and 20th May 2014. On the other hand, the worst one-year performance was -15.35% between 27th Feb 2015 and 29th Feb 2016.
It was a random example but highlighted the difference between the worst performance of the two types of funds.
In summary, if you have cash in hand and want to park it in a liquid or overnight fund, investing in the fund through SIP won't make much sense. However, SIPs for debt funds can be a good idea if you're looking for steady returns in your portfolio and don't have a lumpsum amount.
Note: Calculated using calendar month returns for the last three years. As on 31-May-2022
Padmaja Choudhury is a freelance financial content writer. With around six years of total experience, mutual funds and personal finance are her focus areas.