Post the launch of our stock recommendation product, Prime Stocks, we have been receiving a lot of questions on investing in stocks and building stock portfolios. Our earlier article addressed one popular question on how to build a stock portfolio. In this one, we will try to address your question on whether you should be doing SIPs in stocks, like you do with mutual funds.
Many investors seem to think that applying the SIP route to stocks reduces the risks of equity investing. If they keep acquiring ‘quality’ stocks over many years, they believe, they’ll eventually end up with a portfolio large enough to rival Rakesh Jhunjhunwala’s or get to live off passive dividend income! Brokerages do their best to push this notion along, by recommending stocks specially for SIPping. After all, it is an appealing way to get long-term investors, who would not ‘churn’ their stocks, to generate trades (and brokerages)!
But we think that while accumulating a stock over three or four instalments is fine, taking the SIP route doesn’t work as well for stocks as it does for mutual funds.
It’s all about stock selection
Equity SIP calculators on brokerage websites draw you in with some alluring statistics on how SIPs in ‘quality’ stocks beat the markets and delivered stupendous returns in the last 1, 3 or 5 years.
For instance, you’re told that you just had to run a 36-month SIP in Bajaj Finance to earn an XIRR return of over 45% per cent (as of February 4, 2021) while similar SIPs in the Sensex earned just 21%.
But such calculations are loaded with the hindsight bias that comes from knowing precisely which stocks have delivered blockbuster returns in the last few years. Had you chosen Axis Bank or SBI – both bluechip alternatives – for SIPs at the same time, you’d have made a 16% or 13 % return respectively, severely underperforming Sensex returns.
To have outperformed the Sensex by such a big margin, you should’ve known, back in February 2018, that Bajaj Finance, despite being a NBFC engaged in unsecured lending, was going to ride the retail loan wave and beat even private banks hollow on loan growth, with good asset quality, over the next three years. You should also have been willing to pay a premium valuation of about 5-7 times book value to own the stock.
The Bajaj Finance example goes to show that great returns from stocks, whether through SIPs or lumpsums, come from being right about the prospects of a business and a decent dose of luck that makes the market recognize this. The method you use to invest – SIP vs lump sum– has little bearing on returns. If your stock selection isn’t good, taking the SIP route can lose you money, the same as the lumpsum route.
Timing does matter
For great returns from direct stock investing, you need to strike while the iron is hot. At Primeinvestor, we believe that to create long-term wealth, you don’t just need to identify good businesses to own but also buy them at a price where its prospects aren’t fully reflected in the price.
Irrespective of what some folks may tell you today, no stock remains a good buy at any price and for perpetuity. This is precisely why we don’t immediately put out ‘buys’ on all the businesses we like, but retain many stocks on our watchlist to wait for a better entry point on prices.
Putting your stock investments on autopilot through SIPs may prevent you from timing your entry point into a stock well, robbing you of its long-term return potential.
Plus, when markets correct steeply, as they did in March 2020, you are often faced with a once-in-a-lifetime opportunity to acquire stocks that you always wanted to own. If you take the SIP route rather the lumpsum route to invest during such times, you’d end up acquiring measly quantities of stock, leading to a substantial opportunity loss.
The stocks that figure on our ‘buy’ list today are good portfolio additions for you to accumulate at the current price. Should their valuations turn too pricey, we will be moving them out of the buy list into our ‘hold’ or even ‘sell’ list. Using the SIP route to acquire these stocks may deprive you of the opportunity to buy them when the price is right and exit them when all the good news is in the price.
While accumulating your buys in a phased manner instead of jumping all in, at one shot, is a good strategy to average your price in a bull market, you will be carrying this too far if you wait 3 or 5 years to accumulate a decent position in a desired stock – which is what the SIP route forces you to do.
It may blind you to business changes
One of the key reasons why direct equity investing isn’t for everyone is that it requires constant due diligence.
Even Warren Buffett, who is credited with saying that his favourite holding period is forever, is rather quick to exit portfolio positions where he’s been wrong about business prospects. After sinking over $7 billion in four major US airlines – United, American, Southwest and Delta in 2016 – Buffett exited all four at a loss just four years later in 2020 as soon as Coronavirus struck, admitting that people were unlikely to take to flying as in the past even after the pandemic passed.
Even without world-changing events such as Coronavirus, businesses that we buy are exposed to uncertainties and risks all the time. These can come from changes in macros, consumer preferences, competition or the regulatory environment. Tracking all the factors that may have a bearing on the businesses we own, is thus an unavoidable attribute of direct stock investing.
When you do SIPs in mutual funds, you are committing a fixed sum to an underlying portfolio of stocks that keeps changing over time. You can rely on the fund manager, if he’s good, to monitor the risks to companies in the portfolio and replace them at periodic intervals. You can thus afford to put mutual fund SIPs on autopilot (though carrying this passivity too far can leave you with dud funds), something you can’t afford to do with stocks.
With a direct stock portfolio though, the onus of monitoring such changes is on you. Stock SIPs, by putting your investments on autopilot, can result in your neglecting key fundamental changes to the businesses you own, resulting in your continuing your investments even after the basic investment thesis has been completely invalidated.
Take the case of Zee Entertainment, which just three years ago was a sought-after quality stock that figured in many fund portfolios, thanks to the company’s rising TRP and ad share, lucrative foray into new regional markets and high margin and return ratios. But with the company’s promoter loan saga coming to light in 2019, the stock was battered to a fifth of its peak value by March 2020 and has only lately staging a tentative recovery. Investors who chose the stock for its stellar prospects in 2018 and kept SIPping it till date, would have made a negative XIRR of 8% in a raging bull market!
It can lead to concentration risks
One of the advantages of using SIPs to buy equity funds is that you can accumulate a large equity portfolio over a 5- or 10-year period without feeling the pinch on your pocket. But when you use SIPs in individual stocks, the advantages of building up a large equity position can backfire on you.
In an earlier article on portfolio construction, we had underlined the importance of avoiding concentration risks both on your sector and individual stock positions. By dribbling small sums into a stock every month, stock SIPs may lead you to sink significant sums into a stock and leave you with concentrated portfolio positions in it, without your realizing it.
If your original stock choice turns out to be wrong, concentration can turn out a double-whammy, not only exposing a large proportion of your portfolio to a poor business, but also prompting you to throw good money after bad. Staying off fresh buys in a stock that is already a large portfolio weight and booking partial profits when you are too over-weight for comfort, come more easily with a lumpsum investing (or accumulate) strategy than with a SIP strategy.
So, to summarize:
- Use a phased accumulation strategy for the stocks on our buy lists, acquiring your positions in three or four tranches.
- Avoid SIPs, which may prevent you from timing your entry right and encourage lazy investing.