SIPs are good, but not for all seasons and reasons!

Systematic Investment Plans (SIPs) of mutual funds have drawn the most fulsome praise among all the mutual fund products, and for good reason. After all, SIPs inculcate discipline among investors and, most importantly, SIPs help mitigate the adverse impact of market volatility by averaging out the cost of buying. Due to these obvious advantages, investors in India have made a beeline to invest in SIP schemes during the past few years.

But are SIPs good at all times and for all types? Mutual funds have tried to cash in on the rush by launching SIPs that are inherently risky products. The stock-specific and the thematic SIPs are some of the products that have high levels of risk associated with them. The stock-specific SIPs expose the investors to concentration risk and any adverse movement in the prices of these stocks can erode the value of the investments.

However, since the investor is obliged to keep buying these stocks through the SIP, the erosion in value would be compounded. Since no stock is a permanent buy as market cycles and economic conditions keep changing, it would be imprudent to keep buying the stock when market conditions dictate otherwise. An investor investing in such a SIP is like a punter who keeps betting on a losing horse, so that he keeps losing more and more, while prudence dictates that he stops betting on that horse! Hence, stock-specific SIPs are best avoided to prevent being exposed to concentration risk.

The other risky propositions are the thematic or sectoral SIPs. These are usually the flavour of the season and mutual fund houses expect that the specific sector or theme would do well going forward. But if the sector or theme belies expectations and runs out of favour of the investors and turns for the worse, the investor would be saddled with a bad investment from which there is no escape as he will have to keep investing in the dud theme through the SIP.

In view of the above pitfalls, it would be advisable for investors to invest in SIPs of diversified equity funds, which may offer lower returns, but the risks would be lower too.