InvestorQ : I was told by my mutual fund advisor not to stop my equity fund SIP once started. But what do I do if I need emergency funds?
Debbie Mascarenhas made post

I was told by my mutual fund advisor not to stop my equity fund SIP once started. But what do I do if I need emergency funds?

Crowny Pinto answered.
2 years ago

We will come to the equity fund part later but first step should be to create an emergency fund so that you don’t fall back upon your core investments for your emergency needs. We all know that a systematic investment plan (SIP) on a mutual fund is one of the best ways of creating wealth in the long run. There are quite a few reasons for the same. Firstly, SIP instils in you a discipline to save regularly. People normally end up looking at savings as a residual after your expenses are met. SIP forces you into a discipline of saving and looks at expenses as the residual component. Secondly, SIP is all about rupee cost averaging. Here is how it works. Since you commit a fixed amount to a fund each month, you automatically get more units when the market goes down.

As a regular SIP captures this volatility you will find that the average cost of an SIP will generally be lower than a lump sum investment. Thirdly, SIPs build momentum over a period of time. Since equities are self-compounding, with every passing month your principal and the returns on your principal earn more returns. It is this power of compounding that actually works in your favour. Last, but not the least, SIP helps you to better match your earnings and your savings. This is also true of tax saving ELSS schemes. Instead of rushing to invest in ELSS in the last 3 months, you can run an SIP on an ELSS fund and get the same tax benefits with the added benefit of rupee cost averaging also thrown in.

But the most important aspect you need to remember about an SIP is that you must not terminate your SIP once you have started, till your actual goal is achieved. Here are 3 aspects you need to be aware of about your SIP…

It disrupts your wealth accumulation calculation because your financial plan is based on the assumption that your SIP will continue till the date of the goal

One argument against terminating an SIP midway is that it has got serious implications in terms of exit loads and tax implications. If you end up paying short term capital gains tax instead of long term capital gains tax you are actually paying 15% higher. That is a big dent on your eventual wealth creation. But that is the smaller challenge. The bigger challenge is the impact on wealth creation. Look at the table below:

SIP Details Investor A SIP Details Investor B

Date of starting SIP October 01, 2002 Date of Starting SIP October 01, 2002

SIP Contribution Rs.10,000 per month SIP Contribution Rs.10,000 per month

Tenure of SIP 15 Years Tenure of SIP 10 Years (5 year gap)

Total Investment Rs.18,00,000 Total Investment Rs.12,00,000

Value of SIP in Oct 2017 Rs.82.77 lakhs Value of SIP in Oct 2017 Rs.65.60,000

SIP CAGR Return 18.22% SIP CAGR Return 17.84%

In the above case, Investor B stops his SIP after 5 years and again recommences his SIP in 2012. As on October 2017, he would have invested Rs.6 lakh less but his eventual wealth creation as of October 2017 is nearly Rs.17.20 lakhs lower. This is the wealth loss caused due to premature termination of your SIP. In this case Investor B was lucky that he played the full bull rally from 2002 to 2007 but despite that he ends up underperforming at the end of 15 years.

When you stop your SIP you are actually compromising your long term goals that are mapped to the SIP or the SIP is mapped to

Normally, your investment process begins with a financial plan. As part of the financial plan each of your SIP or investment instrument is mapped specifically against a particular goal. This goal could pertain to your child’s education, part of your retirement corpus, your child’s wedding expenses etc. The moment you terminate a SIP, the expected corpus creation on that SIP gets negatively impacted as we saw in the previous point. That means your goal is likely to get impacted as you will have less than the required resources. This is also true if you are looking at specific SIPs to defray your future liabilities. In case you terminate your SIP in between, your resources may be insufficient to defray the liabilities when they become due. That could lead to an asset / liability mismatch in your personal balance sheet.

How about a mid way solution? There is a subtle difference between discontinuing a SIP and making changes and that is exactly what you should use

There are occasions when you may be logically required to terminate your SIP. The first occasion is when your goal is achieved. If your SIP is mapped to your home equity and if you already created enough to pay your home equity, then you can terminate that SIP, pay your home equity and then take a fresh view on how to invest that money. Secondly, if your SIP is consistently underperforming the peer group, then you need to initiate action. A couple of quarters of underperformance is at times understandable and can be attributed to the vagaries of the market. But if the SIP is consistently underperforming then it is a call to shift your SIP to some other mutual fund. The answer is not to terminate the SIP but to tweak the asset in question. It is very important that once you commence your SIP, you must take to its logical conclusion. Having second thoughts on your SIP and being impetuous about it does not help your cause too much!