A Systematic Investment Plan or SIP, as it is popularly known, is a vehicle offered by Mutual Funds to help investors save regularly by committing a fixed amount of investment in a scheme periodically, normally a month. The units are allotted on the basis of NAV existing on the date of investment.
I have listed below five points in the order of their increasing importance which explain why investment through the SIP route is preferable.
1. Light on your wallet:
Investments in Systematic Investment Plans can be started with amounts as low as Rs. 500/- per month. One can commit the amount as per his choice in multiples thereafter. Hence, it gives regularity in investments without strain.
2. Easier Administration:
Systematic Investment Plans are one of easiest to administer techniques of investment as the investor does away with the need to time the market. The date of investment is fixed and the amount has to be deposited on the same day every month. To further make it easier, schemes offer the facility of auto-debit and ECS (Electronic Clearing System).
3. Disciplined approach:
A majority of investors find it difficult to save and invest on a regular basis. But Systematic Investment Plans help overcome this problem as the investor commits a fixed amount per month and soon inculcates a habit of regular saving by limiting his expenditure.
4. Rupee-cost Averaging:
This is the main reason which explains why SIPs are preferred by investors who do not have the time or expertise to study the market and time their investments. Systematic Investment Plans do not require the investors to plan the timing of their investments. This is because by investing through SIPs, investors automatically buy more when the valuations are low and buy less when the NAV is high.
Let me explain the same with the help of an example:
Suppose an investor has committed Rs. 1,000/- on the 10th of every month. Here is the schedule of his investments at the end of the financial year.
|Date of Investment||Amount invested||NAV||No. of units purchased|
|10 April||Rs. 1,000/-||Rs. 7.50/-||133.33|
|10 May||Rs. 1,000/-||Rs. 8.00/-||125.00|
|10 June||Rs. 1,000/-||Rs. 8.50/-||117.65|
|10 July||Rs. 1,000/-||Rs. 9.00/-||111.11|
|10 August||Rs. 1,000/-||Rs. 9.50/-||105.26|
|10 September||Rs. 1,000/-||Rs. 10.00/-||100.00|
|10 October||Rs. 1,000/-||Rs. 10.50/-||95.24|
|10 November||Rs. 1,000/-||Rs. 11.00/-||90.91|
|10 December||Rs. 1,000/-||Rs. 11.50/-||86.96|
|10 January||Rs. 1,000/-||Rs. 10.50/-||95.24|
|10 February||Rs. 1,000/-||Rs. 11.00/-||90.91|
|10 March||Rs. 1,000/-||Rs. 10.00/-||100.00|
On a careful analysis of the above, it can be seen that the average NAV over time was Rs. 9.75. But the average NAV of the investor’s purchase is Rs. 9.59. This shows that he has gained from the principle of rupee-cost averaging.
This is the most magical effect that small and regular savings have in building one’s portfolio over time. And this also explains the importance of starting investments early. Let me explain the same with the help of certain examples:
Example 1: There are two investors A and B. A starts investing Rs. 10,000/- every year from the age of 20. But B starts investing the same amount from the age of 25. Both of them earn an interest of 15% compounded annually on their investment. By the time their age is 60, the value of their investments is as follows:
It can be seen that the value of A’s investment is almost double the value of B’s investment. And the only difference was that B started investing only 5 years later than A. This is no magic. This is the effect of compounding.
Example 2: There is an investor X. He wants to generate a corpus of Rs. 1,50,00,000 by the time he retires. Let us see how much he will have to save each year when he starts investing at the following ages:
|Age at which X starts investing||Amount to be invested every year|
Note: Please feel free to give your comments.