SIPs beat recurring deposits ::Business Line

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By taking the SIP route, the impact of market volatility is evened out.

Thinking of saving up money for the long term- say, 5 years or more? Many people immediately prefer recurring deposits, but do see if you can take some additional risk.

If so, systematic investment plans (SIP) with mutual funds can give you a much better return.

WHY SIPS

Most people are wary of equity funds, even through the SIP route because they are worried about market gyrations hurting returns.

Since 2002, the equity market has witnessed quite a few major corrections. Had you continued your SIP in large-cap funds or balanced funds, your annual portfolio return would have been 18 to 24 per cent. Had you opted for index funds tracking the BSE Sensex or Nifty, you could still have achieved a return of 15 per cent. For instance, if you invested Rs 1,000 for 120 months from April 2002, your investment was Rs 1.2 lakh but your present value in HDFC Prudence or Birla Sun Life 95 would be Rs 3.86 lakh or Rs 3.10 lakh. In both the schemes not less than 25 per cent of the assets were invested in debt instruments. For the same period BSE Sensex delivered Rs 2.61 lakh.

When you do SIPs in a mutual fund, by investing regularly over a period of time, the impact of market volatility is evened out. As units are acquired at different NAVs, more units are bought when markets are down.At the time of selling, an investor sells all the units at the prevailing NAV and takes out his profits. Under systematic investment plan, one optimises the returns rather than maximising them. For instance, if you start an SIP close to the market peak, you will continue to buy units at higher levels all the way down to the bottom. This may impact the short term return but cost averaging may help you to earn better return than fixed instruments when market turns better.

A Recurring Deposit is an ideal way to invest small amounts of money every month to build a corpus. The advantage with RD is that the interest rate paid by the bank will be the same through out the tenure of the investment. Banks also allow you to take a loan against the deposit account.

Taking the above instance, the interest rate offered by the banks in 2002 was in the band of 5.5-6.25 per cent. Several investors could have opted for the RD during this period. But in the last decade average inflation was at 6.5 per cent and it effectively meant that the returns fail to beat the inflation.

But lower returns do not necessarily make RDs an unsuitable product.  A retiree having monthly surplus in the early part of retirement could use RDs to supplement his income.  Or a person having other equity investments can use RDs to have a safe portion to his portfolio.

A simple thumb rule is that if your retirement corpus is less than 240 times of your monthly need, you could add SIPs based on your risk appetite.

It is best not to use an RD to meet long term goals such as education or marriage expenses.

For instance in April 2002 if you had started RD of Rs 1,000 for 120 months with a return of 6.25 per cent your investment could have grown to Rs 1.67 lakh and your post-tax return could have been still lower. Similarly if you start RD at 9.25 per cent today your maturity value will be Rs 1.97 lakh.

CONCLUSION

A choice between a SIP and RD should be based on three factors - your investment horizon or goals, risk appetite and the state of your portfolio.  Although with RD you can predict the maturity value, you need to factor in post tax returns as your income tax slab increases over the years.

Most people worry about the equity markets turning down when they need their money. But if you completely book profits on your portfolio once your target is reached, you could attain your goal ahead of time. With Rs 1,000 invested in an SIP from April 2002 for 63 months in HDFC Prudence Fund, you could have hit the target of Rs 1.67 lakh in June 2007, with 57 months still left for your target.