Q. I am a 54-year-old cloth trader running a small proprietorship in my hometown Surat. I have been investing in mutual funds through Systematic Investment Plan (“SIP”) since past 15 years. I am worried about the lacklustre performance of the stock market since last year. I have allowed my last 2 SIPs to bounce, I now intend to invest only when the market performance improves. I wish to understand what are the ramifications of skipping a SIP. Multiple friends and well-wishers have told me that I should continue my SIP for rupee cost averaging. However I do not understand the same, can your please elaborate on the same.
Rasik Jain, Surat, Gujarat
Most investors prefer to invest small amounts of money generally on a monthly basis by using the SIP facility offered by mutual funds houses. It is a simple tool which enables investors to make regular investments in the stock market under the guidance of professionals thereby reducing the danger of losses.
Typically, fund houses give investors two options for investing through SIPs. One is through electronic mandates , in this case investors electronically sets-up a ECS/NACH mandate with his bank, i.e., electronically instructing your bank to transfer a fixed amount of money to the mutual fund house on a fixed date of every month. Second is setting up the mandate through physically visiting a bank, where you will be required to fill a form in order to transfer a fixed amount of money to the mutual funds house on a fixed date of every month.
When there is an insufficient amount in the bank account through which the auto-debit mandate has been set-up, a SIP bounces. Mutual fund houses often do not impose or charge any fines when an ECS/NACH mandate fails to process because of insufficient funds in the investor’s bank account. However, it is important to note that in case of NACH/ECS mandate dishonour, the majority of banks charge a "bank charge" or penalty. Every time the SIP mandate fails owing to inadequate bank balance, banks will impose this penalty.
Rupee cost averaging
Under the rupee cost averaging strategy, you invest a fixed amount in one or more mutual fund schemes every month, irrespective of the fund's Net Asset Value (NAV). When the NAV is low, your account gets credited with more units. In contrast, when the NAV is high, you get fewer units. As an investor, you do not worry about the fluctuations in the NAV since your investment amount remains the same every month.
Alternatively, you may invest once every quarter or half-yearly. The rupee cost averaging approach lets you sail over the short-term volatility in market prices to reap rich dividends in the long term. SIP is the best tool to implement the rupee cost averaging strategy.
Rupee cost averaging strategy benefits
The average purchase price declines: You cannot average out your investment when you make a lump sum investment in a mutual fund. As a result, your purchase price will have a huge role in determining the performance of your investment.
The rupee cost averaging method, on the other hand, spreads out your investment. When the NAV is low, the average price per unit falls as you purchase more units. As a result, in the long-run the rupee cost averaging strategy enables you to buy more units for less money and profit as the market rises.
Prevents capital volatility: The greater the volatility, greater is the risk for small retail investors. Most small investors invest in mutual funds solely because they find investing in single stocks too risky, even investing in blue-chip stocks can be much riskier than investing in a mutual fund investing in blue-chip companies. You may defend your capital against the damaging effects of volatility by using the rupee cost averaging strategy.
You portfolio will obtain extra units, for instance, if there is a market crash as a result of high volatility, and as the market eventually rises, your profit margin will rise too. As a result, the rupee cost averaging strategy spares you from choosing the wrong time for making investment in the stock market and consequently getting suboptimal returns.
Affordable investment amount: SIP investments often begin at 500 INR per month. Unlike investment in real estate or gold you can employ rupee cost averaging even for a small amount. This allows for democratisation of investment - people from all walks of life can benefit from rupee cost averaging by investing small amounts through SIP even if the amount is as low as INR 500.
The consequences of stopping SIP can be broadly categorised into two categories (a) Penalty from banks because of dishonour of ECS/NACH mandate and (b) Losing out on rupee cost averaging. In the long-run rupee cost averaging brings down your average cost of mutual fund units and improves the performance of your portfolio.
However, if you have made-up your mind that you are going to stop your SIP it will be better that you cancel the SIP through your mutual fund investment app. If you on the other hand do not cancel your SIP but simply elect to maintain insufficient funds in your bank account linked with your mutual fund app you will be penalised by your bank for dishonour of NACH/ECS mandate.
Kuvera is a free direct mutual fund investing platform.
Note: This story is for informational purposes. Please speak to a financial advisor for detailed solutions to your questions.