SIP reduces only entry-timing risk: Here’s why valuation, liquidity and portfolio concentration still need attention

Systematic Investment Plans (SIPs) are promoted as one of the most disciplined ways to invest in mutual funds. By investing a fixed amount at regular intervals, investors can avoid the need to time the market. However, SIPs are often misunderstood as a complete risk-management strategy.

According to Aditya Agarwal, Co-Founder, Wealthy.in, SIPs only address entry-timing risk and do not protect investors from other critical risks such as overvalued markets, concentrated portfolios, liquidity issues, or poor fund selection.

SIPs smooth market entry, not market volatility

“SIPs are one of the most effective tools for reducing entry-timing risk through rupee-cost averaging, but they should not be mistaken for a risk-management strategy in themselves,” Agarwal said.

He explained that while SIPs help investors avoid investing a large lump sum at market highs, they “do not eliminate risks arising from expensive valuations, portfolio concentration, liquidity constraints, or poor fund selection.”

For example, if an investor starts a ₹5,000 monthly SIP when a mutual fund’s NAV is ₹100, the first instalment buys 50 units. If the market corrects and the NAV falls to ₹80 the following month, the same ₹5,000 investment purchases 62.5 units.

When markets recover over the following years, the investor benefits from a lower average purchase cost. However, the portfolio may still witness temporary declines during the correction.

Agarwal pointed to investors who continued SIPs during the sharp market fall in early 2020. “They experienced temporary declines but continued investing through the downturn, accumulated more units at lower prices, and benefited significantly from the subsequent recovery. But SIPs smooth the purchase cost over market cycles rather than prevent volatility,” he said.

SIPs cannot protect against expensive valuations

The expert cautioned that disciplined investing alone cannot overcome valuation risk.

“If an investor continues investing in segments trading at stretched valuations—such as certain small-cap or thematic funds during periods of excessive optimism—the long-term return potential may still be lower despite disciplined investing,” Agarwal said.

He noted that the recent surge in inflows into small-cap funds despite elevated valuations shows that “staggered investing does not automatically make an expensive asset inexpensive.”

Agarwal also shared an illustration to highlight the valuation risk. He cited the example of an investor who invested ₹10,000 every month for five years in the Tata Digital India Regular Growth Fund, taking the total investment to ₹6 lakh.

While the SIP helped avoid the risk of investing a lump sum at the technology sector’s 2021 peak by averaging the purchase cost, the investment still delivered a slightly negative annualised return of around 0.67% as the technology sector underwent a multi-year derating after valuations became stretched.

Concentration and liquidity risks remain

Another common misconception is that multiple SIPs automatically create diversification.

According to Agarwal, investors who invest through several SIPs in funds with overlapping holdings—for example, multiple technology or PSU-focused funds—may still be exposed to the same sectors and stocks.

“During sector-specific downturns, all such funds can decline simultaneously irrespective of the investment mode,” he noted.

Similarly, SIPs do not reduce liquidity risk. Agarwal cited the closure of six debt schemes by Franklin Templeton Mutual Fund in 2020, where investors faced redemption restrictions because the underlying securities became illiquid.

“The investment route, whether it is lump sum or SIP, did not alter the liquidity profile of the portfolio,” he added.

Sharing the key lesson for investors, Agarwal said, “A prudent investment strategy combines SIP discipline with periodic portfolio reviews. Diversification across market capitalisations, investment styles and asset classes remains essential, as SIPs alone cannot eliminate all investment risks.”