Are stock specific SIPs better, or SIPs in MFs?

Purported benefits of stock SIPs must be taken with a pinch of salt as they come with their share of pitfalls

June 21, 2020 10:58 pm | Updated 11:09 pm IST

Cartoon man wearing full suit and bow tie balancing cross and tick symbol on two weighing trays on both arms. Creative vector illustration for ethical dilemma concept isolated on grey background.

Cartoon man wearing full suit and bow tie balancing cross and tick symbol on two weighing trays on both arms. Creative vector illustration for ethical dilemma concept isolated on grey background.

With the Systematic Investment Plan (SIP) route taking off for mutual funds, stock brokers are now offering SIPs for direct equity investments as well that allow you to dribble equal monthly sums into a stock of your choosing over several years. This strategy, many folks believe, helps retail investors build up sizeable positions in quality stocks that can turn huge wealth creators in future. But stock SIPs, for retail investors, are not as hot an idea as mutual fund SIPs. Before you sign up for them, here are some things to be aware of.

Stock choice matters

When plugging stock SIPs as a wealth creation tool, you are often provided examples of X or Y stock that transformed an investment of a few thousands into a few lakhs over a relatively short time frame. For instance, had you done a SIP of just ₹5,000 a month in the Hindustan Unilever stock over the last five years, you’d be sitting on shares worth ₹5.1 lakh today, against an investment of ₹3 lakh. But such examples tend to be coloured by survivorship bias. When showcasing the SIP route for stocks, intermediaries often pick companies that survived and delivered a hefty return over the last 5 or 10 years. Companies that folded up or went downhill are ignored. For every HUL that has created wealth, there are scores of other equally well-known names that have decimated wealth in the same period. Had you chosen Zee Entertainment (which was equally fancied five years ago) instead of HUL for your SIPs, your ₹3 lakh investment would be down 56% and worth ₹1.31 lakh today. Leverage problems for Zee’s promoters have badly impacted the stock’s performance. While investing in stocks, therefore, it is not really the SIP mode of investing that helps you create wealth but selecting the right stocks to buy. It is your ability to scour businesses and stock valuations to spot potential wealth creators ahead of others in the market that delivers results.

When you do SIPs in an equity mutual fund though, you are investing in a basket of stocks chosen by a professional manager. Yes, he too may go wrong. But given that stock selection for him is a full-time profession, he’s likely to be more prompt in weeding out stocks when their finances take a trip downhill. A mutual fund’s diversified portfolio ensures that even if a few stock choices don’t work out, others shield your wealth from excessive destruction.

What’s quality

Advisers promoting stock SIPs usually assure you that if you choose ‘quality’ stocks to invest in, you can’t go wrong. Just pick companies that are delivering strong earnings growth with good governance and high shareholder return ratios, and you’ll be assured of long-term wealth creation.

But this oversimplifies the process of stock selection, because the market’s definition of what is ‘quality’ and its assessment of the sectors that can deliver sustained growth changes quite often.

The Indian market, in the last two decades, has seen three big bull markets — each with a completely different set of sectors leading. In 1997-2000, technology, media and telecom stocks were considered the very epitome of quality with scorching earnings growth and high return ratios that everyone thought will continue into perpetuity.

But had you picked from some of the top ‘quality’ stocks of that time — Infosys, Satyam Computers, Digital Globalsoft, Zee Telefilms — you may have found yourself poorer as two of the four haven’t even survived till date.

Between 2003 and 2008, capital goods, real estate, power and infrastructure stocks, were deemed the best bets. But when India’s growth story hit a wall after the global financial crises, capex came to an abrupt halt, leaving those companies saddled with high debt and rapidly deteriorating earnings. Favourites of this era such as Unitech, BHEL, Suzlon Energy, Lanco Infra and Reliance Communications have barely survived the decade having plunged by over 90%. If you selected BHEL, without material governance issues, and had run a monthly SIP in BHEL for 5 years from June 2005 to June 2010, your investment of ₹5 lakh then would be worth only ₹50,000 today. Even in non-cyclical businesses with steady earnings like FMCGs, valuations shrinking sharply can lead to wealth erosion.

Yes, mutual fund managers can err by chasing after the wrong stocks. But they are usually forced to correct their mistakes quickly when market preferences change. This ensures that even if you continue your SIP in the same fund, its portfolio is dynamic, and you don’t keep pouring money into dud businesses.

To achieve a good balance of risk and returns in your portfolio, you need to closely watch the weights that individual assets and stocks take up in it. When weights run up too fast, it is best to rebalance by liquidating some positions. The higher the concentration in a single stock or sector, the more of your wealth is exposed to the risk of that bet going bad. Taking a measured exposure to a stock or sector is easier with lumpsum investments. With SIPs, you can keep pumping money into a single stock for years bloating its weight in your portfolio.

Consider a person with a ₹10 lakh portfolio who runs a ₹5,000 monthly SIP in a single stock for 5 years. After the five-year period, his exposure to the stock will amount to ₹3 lakh, as much as 23% per cent of his portfolio, assuming the stock moves in tandem with the rest of the portfolio. Had the stock outperformed, its portfolio weight can rise even more quickly. Unless you a keep close watch on your portfolio weights while running SIPs, you can run a big concentration risk.

Just like stocks, unmonitored SIPs in mutual funds can also lead to a single fund occupying a very large weight in your portfolio, which is risky. But given that funds own a basket of stocks, this still exposes you to lower concentration risks than stock SIPs.

Finally, the secret to creating enduring wealth from stocks is regular tracking of the business you have invested in.

Having bought a stock based on an investment thesis, you will need to check into its quarterly results, statutory filings and events relating to its governance to ensure that your money is in good hands. SIPs tempt you to put your investments on autopilot. Let’s also admit that to really generate wealth from stocks, timing your entry and exit is critical. No stock is a perpetual ‘buy’ at any price and valuation. A SIP offers you the means to avoid timing risks on entry, but you still have to know when to exit. Overall, the simplest way to run SIPs is to do so on index funds where neither stock selection nor fund manager selection can derail your wealth creation.

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