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I defaulted on my SIP Installments; what should I do now?

The extreme volatile conditions in the recent past in the markets have led to hysterical selling by many investors. And this panic-stricken selling is not limited to stocks alone.

There were many investors who have redeemed their mutual fund schemes and have stopped their monthly SIPs too.

However, if you look at it from the other side, these (volatile falling markets) are the best opportunities to keep investing in the SIP’s and average your cost.

In case of investments, when the going gets tough (this time it went even tougher!), the tough doesn’t get going, we get driven by our emotions.

Just like it did for 27 year old Vikas Saxena!

Vikas is into a job in the IT (Information Technology) Industry and stays with his friends on a sharing basis in Pune, India. He likes to go out on the weekends and hang out with old friends. Also, he takes a keen interest in investing in stocks and mutual funds.

In December 2007, he thought of starting an investment and activated a monthly SIP of Rs 1000 into the Reliance Diversified Power Sector Fund, for a period of 5 years.

Initially, when the markets were heading towards achieving new heights (in Jan 2008), Vikas carried on with the SIP as he was happy enough because during that period, his investment gave handsome gains. However, when the markets started falling, Vikas (intentionally) defaulted on his SIP and since March 2008 did not pay his monthly SIP installments as psychologically he thought that there was no use investing now. Now that he has accumulated the funds over the last seven months (Rs 7000), he wants to invest a lump sum amount now when the market have bottomed out.

He has the following questions in mind now which got me to write an article on this:

- Whether it was the right thing to default on his SIPs when markets started falling.
- If this will have any impact his overall credit rating with the bank.

EquiTipz clears Vikas’ dilemma. So, below we will take these cases one by one.

  • Was Stopping the SIP installment the right thing to do?

Let’s look at two scenarios to find the answer:

Case 1: He invests the accumulated amount (Rs 7,000) as lump sum in October:
SIP date Amount Invested (Rs) NAV (In Rs) Units allotted
3-Dec-07 1,000 78.35 12.76
3-Jan-08 1,000 87.74 11.40
3-Feb-08 1,000 75.53 13.24
22-Oct-08 8,000 (lump sum) 40.78 196.16
Total 11,000 Average cost = 47.09 233.56

Note: SIP was made in Reliance Diversified Power Sector Fund

In this case, Vikas would have received 233.77 units at an average purchase price of Rs 47.09.

Case 2: He continues with his SIP
SIP date Amount Invested (Rs) NAV (In Rs) Units allotted
3-Dec-07 1,000 78.35 12.76
3-Jan-08 1,000 87.74 11.40
3-Feb-08 1,000 75.53 13.24
3-Mar-08 1,000 66.02 15.15
3-Apr-08 1,000 61.04 16.38
3-May-08 1,000 68.18 14.67
3-Jun-08 1,000 60.30 16.58
3-July-08 1,000 52.91 18.90
3-Aug-08 1,000 59.28 16.87
3-Sept-08 1,000 57.63 17.35
3-Oct-08 1,000 50.20 19.92
Total 11,000 Average cost = 63.50 173.22

Note: SIP was made in Reliance Diversified Power Sector Fund

In the Case 2, he would have received 173.22 units at an average cost of Rs 63.50.

If you look at this case, at first instance, it might seem to you that Vikas made the right move by defaulting first and then paying the accumulated amount as lump sum, Since investing a lump sum at this stage would give him more units at a lower price.

But was he right? The Answer is NO!

Using this strategy cannot help Vikas to build long term wealth. Surprised?

Here’s the reason:

- Timing the markets is never possible. Even if Vikas successfully reduces his buying cost now (in Case 2), he cannot predict the market moves at all times. For instance, what if the NAV falls to Rs 30 or Rs 25 right after his lump sum investment? What would he do in that case? This is the case where SIPs come to your rescue! They rule out the effect of markets’ ups and downs.

- He initially decided to invest for a period of five years. Breaking this investment in the middle waives off the very purpose of building wealth in the long term.

- SIP inculcates investment discipline. Truly, a commitment of a small sum is all it takes to generate good returns over the long term.

Remember “If you regularly miss out on your SIPs, it may impact your corpus considerably”

Will the default hamper his credit rating? The answer is NO.

SIP is a regular investment, unlike a loan EMI which is a regular payment (in which you owe money to the bank). The very purpose of SIP is to invest a regular sum of money at pre-determined intervals (fortnightly, monthly etc). This investment is made either through post dated cheques or electronic clearing services (ECS) in which the mutual fund system debits the amount automatically from your bank account on the given date.

If you don’t have money in your bank account for a given month, no units will be allotted to you for that month.

So, the bank has nothing to object whether you continue your SIPs or not. Hence, this will never impact your credit rating with the bank.

Disclosure: "No Positions"