Investors can buy financial assets for the purpose of investment in two ways. They can pay lump sum amount and buy once. In this case, any adverse impact on the value of asset will reduce the investment returns. The other option is to invest a sum periodically. In this case, adverse impacts will not hurt drastically. The periodic investment option is also known as SIP.
SIP or systematic investment plan is a scheme where investors can invest a certain amount every period (daily, weekly, monthly, quarterly, or yearly) in a financial asset up to the investment horizon. For example, the investors can invest 10,000 every month for next 3 years in a mutual fund.The idea behind this concept is that this normalizes the fluctuations in the asset prices.
Almost all value investors have encouraged the use of SIP by individual investors to diversify the price fluctuation risk. SIP is also known as rupee cost averaging.
How it works
You have to define three component of SIP, namely, amount to be invested, frequency of investment, and time horizon for investment. Let’s use month as a period. Let’s say an investor invested 5000 in the month of Jan (on 15th Jan) in Birla sun life mutual fund. If the NAV is Rs 25, he can buy 200 units of the fund. In the month of Feb, 2011 (on 15th Feb), he invests another Rs 5000. The price of a unit is now Rs 27. Hence our investor can buy 5000/27 = 185.18 units. The average price of the unit will be total money invested / number of units purchased = 10,000 / (200 + 185.18) = Rs 25.96. This will keep repeating till the time you have set as your investment horizon.
Here what you are doing is that you are averaging the price of unit. If the prices go up, you get less units of mutual funds while if the prices go down, you get more of the units.
You can invest in equity funds, balanced funds, or debt funds using SIP.
Advantage of SIP
SIP is the best for individual investors who do not have time to follow the market and stock movements. You do not need to worry about the fluctuating prices or market timing but keep investing a certain amount.
SIP allows you to average the price you are paying for the units. It is the best defence against fluctuating price of the financial assets.
SIP can be started by any amount. Some brokerages allow as little as Rs 500 a month. You can start investing with Rs 500 a month to avail the benefit of SIP.
It incorporates a disciplined behaviour in investors. This helps you build wealth over time. The number one reason for investors to lose wealth in stock market is greed and undisciplined approach to investing.
How to proceed with SIP:
Investing the SIP way is easy. All you have to do is to let your bank allocate a certain amount of money to be invested in a fund every month. Once you do this, banks will let the mutual fund house deduct this amount from your account and invest in the funds you have selected.
You can also define the timeline till which the bank will keep investing. Once the timeline is passed, the banks will stop investing in the fund. This means if you authorize your bank to invest Rs 5000 every month for next 3 years, the bank will keep taking Rs 5000 every month and invest in the fund of your choice till 3 years last. At the end of 3 years, the bank will stop the investment. You can choose to liquidate your investment, leave it as it is and let it grow in value, or extend the SIP.
You also have option to give post-dated cheque of the amount you want to invest as part of your systematic investment plan.
If you are disciplined enough to do this on your own, you do not need the automatic SIP. However, the problem with most of us is lack of discipline.
While you can take any period as payment for SIP, the funds offering the SIP plan may differ. Today most of the funds offer SIP as a way of investing.
There is concept of daily SIP in the market too but the number of funds supporting daily SIP is less. You can find out more from the individual mutual funds about the SIP scheme acceptable to them.Ideally, monthly SIP makes senses as we get our salary monthly and it is easier to manage monthly income and expenses than to manage other periods.
SIP is a great tool in the arsenal of common investors who want to build wealth over longer period. The market fluctuation and risk are much better managed with SIP than any other method.
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The author Pankaj Priyadarshi is a financial consultant and you can contact him directly at
. He is B.Tech from IIT, Kharagpur and MBA from ISB, Hyderabad.