By Gaurav Dutta | 10-03-14 | Morningstar

Should you venture on a google search of the term ‘systematic investment plan’, you will be supplied with a barrage of information extolling the strategy’s virtues. In fact it is positioned as a silver bullet approach for investing in equity mutual funds.

Are we saying it is not good? Not at all. Is it a sure-fire way to win? Well, not quite.

In 3 investing myths, we briefly touched upon this issue. Let’s dig deeper.

The logic

Systematic Investment Plans, or SIPs, are expected to curb volatility, both on the upside as well as downside. This is done by cost averaging since the investments are made on a periodic basis, and not in a lump sum. Though the investment amount is fixed, more units are purchased when the market trends downwards, and fewer units when the market moves up.

If compared with lump-sum investing, cost averaging does not work to the investor’s benefit in a rising market. It would be great if the investor invested a huge amount at the start of the climb and stayed put. But that would amount to timing the market which is easier said than done. An SIP in a rising market would amount to every new purchase being made at a higher cost.

Let’s look at a comparison between a lump sum investment of Rs 12,000 and a monthly SIP of Rs 1,000 over a period of 12 months. Say you purchase 1,200 units of a fund by investing Rs 12,000 at the start of the year. If prices consistently move up during the year to Rs 20, you would make a 100% profit as you purchased your units at Rs 10. But, during the same period, had you invested via the SIP route, you would have made much less. Under the SIP format, an investment amount of Rs. 12,000 would be split into 12 equal monthly installments of Rs 1,000 each. This way you would purchase only 100 units at Rs 10 (compared to 1,200 units under lump sum). All subsequent purchases would be made at higher prices, reducing overall returns.

On the other hand, the returns will be comparatively better off during market downturns.

What the numbers say

A look at the above two examples indicates that SIP returns were better off during the market downturn of 2008, or the sideways market of 2013. But, what stands out the most is the poor performance of the SIP during the bull run of 2009-10.

Thus, while cost averaging cushions your investment during a downside, it also irons out gains made in a bull run to some extent.

So what are we saying?

Investing systematically does have its limitations but it is still the best way to invest in an equity mutual fund. (However, in the case of a sector fund, it would make sense to enter when the sector is going through a rough patch).

An SIP enforces a savings over all market upheavals and downturns. It eliminates any behavioural traits that can work against you. It also pushes you to save consistently specially if you do not have the money required for a lump sum investment. But to be effective, it needs to be sustained over a long time frame or at least an entire market cycle. The numbers in the examples above bear this out.

Source : http://goo.gl/MJPpAX