First the mutual fund advisors told us that mutual funds earn a lot of money, implying that ALL mutual funds earn a lot of money. I showed you they do not. Read why they do not click here. Then the mutual fund advisors told us that the equity mutual funds will bring very high returns. The recent turmoil in the stock markets put an end to that claim. Then they told us that debt funds are safe. Again I showed you with proof why they are not safe. Click here for the article. And somewhere in between we were told that Balanced Funds were safe. Read why they are not click here.

The latest claim when both equity markets and debt markets are currently going through high volatility and facing even higher risks, the “financial experts” are telling us that SIP is the way forward. Let us not get carried away by their arguments. The arguments put forth by the financial advisors are arguments of convenience, made more by salesmanship rather than scientific thinking. To understand the fallacies of their argument let us take a look at how SIP actually works and what benefits it gives investors.

How does SIP work?

Suppose I invest Rs. 100 every month in SIP. In the first month I buy units @ Rs. 10, therefore I get 10 units. In the second month the price of units has gone up and I get say 9 units for Rs. 100. In the third month when the price goes up even further I get, say 8 units. Now in the fourth month the price of the units falls and I manage to get 9 units for my Rs. 100 investment. In the fifth and sixth months I get, e.g. 10 and 11 units, respectively. I now have after 6 months, 57 units for an investment of Rs.600 in all. the average price of my units is Rs. 600/ 57 units = Rs. 10.53 per unit. By following the SIP route to investment, I have spread my risk of higher prices over a six-month period. The higher price per unit paid in the second and third month were to some extent offset by the lower prices in the fifth and sixth months. So to some extent the price volatility is evened out in SIP. This is the reason SIP is also referred to as rupee cost averaging. That is the cost of investing is averaged over a period of time. This is only one aspect of risk.

Examples of current risks of investing in mutual funds

There are many other risks associated with mutual funds. The other risks may be

• Large investors will suddenly exit the market leading to a drop in prices,
• The US may raise its interest rates and financial markets in India are adversely affected
• The political situation in the country may not be conducive for business
• There may be large payment defaults by borrowers to banks
• There may be a recession in the economy
• Inflation may go out of control
• The oil prices may increase substantially
• The US may impose severe trade sanctions on India for buying oil from Iran

And many other risks which affect the prices of shares and of debt and therefore the NAV of mutual funds. In fact many expert opinions on the current economic situation in the country are increasingly pointing out that some of the risks mentioned above are very real. For example, the IL&FS default on repayment of their debt to banks and NBFCs, comes very close to the real thing. If IL&FS goes down, first a large part of the financial sector and consequently other sectors in the economy will be severely affected.

Empirical Evidence (Read Bull Run or Bear It is never safe to invest in mutual funds)

1. Roughly about half the mutual funds at any given time earn less than 8 % p.a. If you have a SIP in those mutual funds earning more than 8 %, you will probably earn high returns.
2. Mutual funds do not earn high returns year on year. In fact most mutual funds do not earn high returns in any year of their existence. In some years they earn higher returns and in other years they earn lower returns.
3. Investing in a mutual fund SIP does not guarantee higher returns. The only gain from SIP is that to some extent it irons out the volatility of NAV price fluctuations.

Investing decisions are common sense

As with all investment decisions, finance is mere common sense. Whether the investment is made in a lump sum amount or through SIP, the fact remains that investment in mutual fund is high risk. The characteristic of high risk does not vanish just because the investment route is SIP. Only those investors with adequate risk appetite should invest in mutual funds.