There are myriad benefits of investing through a Systematic Investment Plan (SIP). It gives you an exposure to the asset class of your choice in a systematic manner, precluding the need to time the markets. Additionally, it also helps you reap the benefits of compounding and rupee cost averaging. However, one must understand that there is a certain risk involved in every type of investment and every investment vehicle comes with its own set of challenges. There are certain factors that one must be aware of when making an investment through SIP.
- Point-to-point risk – due to the very nature of equity markets, SIP cannot guarantee a fixed return at the end of the investment time horizon. It is always and entirely possible that you might have garnered enough funds early on but when you reach the end of the investment tenure, the value of those funds might fall. While this is largely a function of the markets, you can mitigate this risk by exiting your equity SIP 8-12 months before the end of the investment tenure and shifting to a liquid fund as you approach your goal.
- Averaging doesn’t work efficiently when your corpus grows – in an SIP you invest a fixed amount of money on a periodic basis. This helps you reap the benefit of rupee cost averaging. However, as the investment corpus grows, the benefits of rupee cost averaging can somewhat recede. You can mitigate this risk by choosing to do an SIP top-up. By increasing the SIP amount in tandem with the growth in corpus one can ensure that averaging is done effectively.
- Opportunity loss when markets are cheaper – equity markets periodically give investors an opportunity to buy stocks at compelling valuations. A simple SIP may not be able to take advantage of market dips. In such a situation, investors can choose to increase the amount they invest through an SIP.
The dual goal of portfolio management is to mitigate risks while generating returns. A SIP can be a good vehicle for the retail investor to gain exposure to equities in a systematic manner. However, in order to harness the true benefits of an SIP, investors should be aware of certain inherent challenges. A financial advisor is well positioned to identify the risks inherent in each investment type and accordingly recommend solutions.