Is It Time to STOP Drinking Stocks SIP by SIP?

Summary: The idea at the heart of systematic investment plans (SIPs) is cost averaging and it works when the stock market goes both up and down. In the last seven years, the market has largely gone only one way and that’s up. Hence, SIPs have given fairly ordinary returns.  

In the last decade and a half, regular investing into equity mutual funds through the systematic investment plan (SIPs) route has become a regular habit for many middle-class Indian investors. And its been a good habit.

Given that money invested in equity mutual funds is used to buy stocks, SIP investors end up owning stocks indirectly.

Also, mutual funds need to invest in a certain minimum number of stocks to meet regulatory requirements, hence, the old investment adage of don’t put all your eggs into one basket, gets taken automatically care of.

Nothing Works Forever

As the old Hero Honda advertisement went, fill it, shut it, forget it. SIPs are a tad like that.

The trouble is nothing works forever. What made SIPs such an easy and a beautiful way to invest is the concept of cost averaging that comes into play.

What exactly is cost averaging? Let’s say you invest Rs 10,000 per month into a mutual fund through an SIP. On the day of investment, the net asset value (NAV) of a single unit of the mutual fund is Rs 40. You end up buying 250 units (Rs 10,000 divided by Rs 40). The NAV of a mutual fund is the price at which an investor can buy or sell a single unit of the fund.

Let’s say a year later, the stock market has fallen and the NAV of the mutual fund has fallen to Rs 20. This time when you invest you end up buying 500 units (Rs 10,000 divided by Rs 20).

Essentially, you end up buying more units when the stock market is doing badly, and you buy fewer units when the stock market is doing well. When the market recovers, it is the units that were bought when the NAV was low, which bring in the maximum return.

Also, since most retail investors don’ know exactly when the stock market is going to fall (this is not to say that the so-called experts and talking heads on TV, do), an SIP strategy needs the investor to keep investing for the long term. The question is how long is the long term? Of course, there is no definitive answer for this.

I still remember when mutual funds first started talking aggressively about SIPs a decade and a half back, they used to talk about an investment horizon of three years. A few years later this investment horizon became five years.

In my personal experience, having invested in mutual funds through the SIP route for nearly 15 years, I think the real fun starts only after ten years. This is when the stock market has gone through various cycles and the investor has ended up buying enough mutual fund units during periods when the stock market was doing badly.

And as mentioned earlier, these are the units help the investor earn a good return when the stock market starts to do well again.

Of course, this is not the best possible way to invest but a pretty optimum one, especially for individuals who are busy running the rat race of corporate life and trying to balance it with their very demanding family and social lives as well. All this doesn’t really leave much time for them to research and invest in stocks directly. Hence, investing in stocks through the SIP route turns out to be a reasonably good bet.

The corollary to all this is that for SIPs to work the stock market needs to come down time to time as well.  Only then does the SIP investor end up buying units at lower NAVs, which benefit him later (I know I can’t seem to hammer this point enough).

But over the last few years, the stock market has only gone in one direction and that is up. Take a look at Figure 1, which basically plots the price to earnings ratio of the Nifty index.  It might look a tad complicated to everyone who switches off when they look at any chart but believe me this is very simple.

Figure 1: Price to earnings ratio of the Nifty 50 Index.


Let’s divide the chart into two parts, pre 2013 and post 2013. Pre 2013, the price to earnings ratio has gone up and down and up and down and so on. Post 2013, it has largely gone only one way and that is up (except the one big fall earlier this year).

What does that mean? It basically means that the prices of stocks that make up for the Nifty 50 index have gone up much faster than the earnings of the companies these stocks represent.  And this has gone on for seven years now.

Stock prices ultimately should be a reflection of expected future earnings of any company. But when the price to earnings ratio keeps rising for seven years at a stretch what it means in simple English is that the price of the stocks has gone up much faster than their earnings and the expected future earnings of the companies have never really materialized.

As of August 18, the price to earnings ratio of the Nifty 50 index stood at 32.03, the all-time highest level (in the data that is available since 1999). The average price to earnings ratio since 1999 has been around 20. This tells us clearly how high the current stock price to earnings ratio is.

The question is how did we reach here? Take a look at Figure 2, which basically plots the inflows or the money being invested into SIPs every month, since April 2016.

Figure 2: SIP inflows (in Rs crore).

Source: AMFI India.

Before we interpret Figure 2, let’s take a look at Figure 3. Figure 3 plots the money invested by foreign institutional investors (FIIs) into Indian stocks over the years.

Figure 3: FII investment into Indian stocks (in Rs crore). 

Source: NSDL.

What Figure 3 tells us is that between 2015-16 and 2019-20, foreign investors did not invest much in Indian stocks, except in 2016-17, when they invested Rs 55,703 crore. Hence, during that period it was money coming through the SIP route which was invested into equity mutual funds and then into stocks, that kept the stock prices buoyant despite the company earnings not seeing the expected growth.

As ironic as it might sound, it was money coming in through the SIP route which essentially ensured that stock prices did not fall, and in the process ensured that cost averaging went out of play.

Before SIPs became a popular of investing, between 2012 and 2014, the foreign investors invested a lot of money into Indian stocks. Money invested by the foreign investors and SIP investors over the last seven years has ensured that the Indian stocks have been at levels their earnings do not justify. Nonetheless, the hope still persists that these stocks will someday give earnings they are expected to. But hope cannot be an investment strategy.

Hence, the part of cost averaging where stock prices fall and which leads to SIP investors ending up buying more mutual fund units, hasn’t really played out in the last seven years.

Take a look at Table 1 which basically lists the SIP returns of three index funds, as of August 18, 2020. Index funds are mutual funds which invest in stocks that make up for a particular index.

Table 1: SIP returns of index funds.

Source: Value Research and National Stock Exchange.

What does this table tell us?

1) Over the last few years, the stock market has just gone one way and that is up. This has led to fairly limited SIP returns. Even the 10-year SIP returns of index funds are not in double digits. And if 10-years is not long enough, I don’t know what is.

2) What we also come to realise is that the SIP returns are on the lower side, despite the stock market valuation being at an all-time high level. Hence, all the money brought in by the SIP investors and the foreign investors has led to just about mediocre returns even over a 10-year period.

Lest we get accused of looking at the returns only on a certain date, let’s take a look at 10-year returns of these index funds in previous years.

Table 2: 10-year SIP returns of index funds.

Source: Value Research.

Table 2 makes for a very interesting reading. The 10-year SIP returns in years before 2020, are higher. In fact, if we leave out 2019, largely they are in double digits or very close to double digits. The reason for this lies in the fact that the 10 year-SIPs before 2019, ran through a longer-periods of the stock market going down (go back and look at Figure 1 again). This allowed cost averaging to come into play properly, something which hasn’t happened in the past few years.

Using this logic, a few months back I completely stopped all my SIPs. Honestly, there hasn’t been a more SIP man than me, having relentlessly been at it for close to 15 years. Whatever little I have saved in life is thanks to SIPs.

Of course, this is the past.

What about the future?

As long as the direction of the market stays one way and it doesn’t fall for an extended period of time, SIPs as a way of investing will have a fundamental flaw, as explained earlier. Hence, the 10-year returns one saw around between 2014 and 2018, are unlikely to be repeated in the years to come.

For a period of 18 months between November 2018 and May 2020, more than Rs 8,000 crore was invested into mutual funds every month through the SIP route. In the last two months, the investment has fallen below Rs 8,000 crore, nevertheless, it still remains strong. A bulk of this money has gone into equity mutual funds.

The foreign investors ignored Indian stocks for the last few years. But in 2020-21, the current financial year, they have come back with a bang. The reason for this lies in the fact that there a lot of money printing happening across the Western world.

Between February 26 and August 12, the Federal Reserve of the United States has printed close to $2.8 trillion in a bid to drive down interest rates in the United States and help the post-covid economy.

As has been the case in the past, some of this money has been invested in stock markets all across the world including India. The easy money policy of the Western central banks is likely to continue in the months to come, at least for the next one year, until the world starts coming out of the economic contraction that is happening thanks to covid.

In this scenario, the chances of the stock market and the price to earnings ratios falling, are rather low. Another reason which will ensure that stock prices may not fall is the fact that post tax bank fixed deposit return is now lower than 5% in most cases and the inflation is close to 7%. Hence, a segment of savers will try to drive up the investment return by buying stocks.

Whether the stock market will go up from here, the situation is too convoluted to say anything definitively. For that to happen, much more money needs to be invested into the stocks.

If as an investor you feel that stock prices will only go up from here despite the lack of company earnings, then you are better buying stocks directly and making irregular one-time investments into equity mutual funds than going through the SIP route. By going through the SIP route, you will keep escalating the cost of purchase of mutual fund units and in the process drive down returns.

That’s the way I see it at least. And I say it, the way I see it. The time to fill it, shut it, forget it, when it comes to SIPs, is over.

Disclaimer: The article is meant for educational purposes only.