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

With the Systematic Investment Plan (SIP) route taking off for mutual funds, stock brokers are now offering SIPs that allow you to dribble equal monthly sums into a stock of your choosing over several years. 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. For instance, had you done a SIP of just Rs. 5,000 a month in the Hindustan Unilever stock over the last five years, you’d be sitting on shares worth Rs. 5.1 lakh today, against an investment of Rs. 3 lakh. But such examples tend to be coloured by survivorship bias. 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 Rs. 3 lakh investment would be down 56% and worth Rs. 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 in the market that delivers results.

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.

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. If you had run a monthly SIP in BHEL for 5 years from June 2005 to June 2010, your investment of Rs. 5 lakh then would be worth only Rs. 50,000 today.

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. With SIPs, you can keep pumping money into a single stock for years bloating its weight in your portfolio.

Consider a person with a Rs. 10 lakh portfolio who runs a Rs. 5,000 monthly SIP in a single stock for 5 years. After the five-year period, his exposure to the stock will amount to Rs. 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.

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