Systematic Investment Plan

What is SIP (Systematic Investment Plan)

SIP is a method of investing a fixed sum, regularly, in a mutual fund scheme. Systematic Investment Plan (SIP) is a smart financial planning tool that helps you to create wealth, by investing small sums of money every month, over a period of time. Systematic Investment Plan is like a recurring deposit with the post office or bank where you put your money every month except the amount is invested in stocks

What is a Mutual Fund?

A mutual fund is an entity that pools the money of many investors to invest in different securities. Investments may be in shares, debt securities, money market securities or a combination of these.

Quite simply, a mutual fund is a mediator that brings together a group of people and invests their money in stocks, bonds and other securities.
Each investor owns shares, which represent a portion of the holdings of the fund. Thus, a mutual fund is one of the most viable investment options for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.

Why SIP

BENEFIT NO.1 : RUPEE COST AVERAGING

SIP allows an investment in Stock Market. It is also known as Rupee Cost Averaging. Lets say you are investing Rs.1000 every month, when the market price of shares falls, the investor benefits by purchasing more units and is protected by purchasing less when market price rises

The biggest advantage of SIP is that one need not time the market. In timing the market, one can miss the larger rally and may stay out while markets were doing well or may enter at a wrong time when either valuation have peaked or markets are on the verge of declining. Rather than timing the market, investing every month will ensure that one is invested at the high and the low, and make the best out of an opportunity that could be tough to predict in advance. SIPs thus make the volatility in the market work in favour of an investor and help in averaging out the cost called Rupee Cost Averaging.

Rupee cost averaging in action

Lets look at an example to make all this a bit clearer. Ajay has been investing Rs 5,000 per month in a particular equity fund scheme since October 1999. The table below shows the purchase price Ajay paid for the units each month as well as the number of units Ajay purchased.

Regular Date Investment Purchase Price per Unit No. of Units received
Oct 1999 Rs. 5,000 Rs. 10 500
Nov 1999 Rs. 5,000 Rs. 9 556
Dec 1999 Rs. 5,000 Rs. 9 556
Jan 2000 Rs. 5,000 Rs. 8 625
Feb 2000 Rs. 5,000 Rs. 7 714
Mar 2000 Rs. 5,000 Rs. 7 714
Apr 2000 Rs. 5,000 Rs. 6 833
May 2000 Rs. 5,000 Rs. 6 833
June 2000 Rs. 5,000 Rs. 6 833
July 2000 Rs. 5,000 Rs. 7 714
Sept. 2000 Rs. 5,000 Rs. 9 556
Oct. 2000 Rs. 5,000 Rs. 10 500
Total Rs. 65,000 8,648

A brief glance at the table reveals the benefits of Rupee Cost Averaging. When the purchase price was high (eg. Rs 10 in Oct 1999), Ajay bought fewer units (500) and when the purchase price was low (eg. Rs 6 in Apr 2000), he bought significantly more (833).

The benefits of this strategy are twofold:

The average price Ajay paid for the units was Rs 7.52* (the total cost of the units – ie. Rs 65,000 divided by the total number of units purchased – ie. 8,648). This is less than the average market price over the period (Rs 7.77*) even though Ajay was not even trying to “time the market”.

In Oct. 2000, the value of Ajay’s investment is approximately 33% higher than what it originally cost him (Original cost : Rs 65,000 Current value : Rs 10 x 8,648 units = Rs 86,480 ), even though the purchase price in Oct. 2000 was the same as it was in Oct. 1999 (ie. Rs 10). By investing regularly, Ajay bought units as the price was falling and was able to benefit from price appreciation as the market recovered. So Ajay has avoided the stress of timing the market but has still done very well on his investment. The key – Rupee Cost Averaging which, in simple terms, just means investing regularly. *Approximate value rounded upto two decimal places.

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