Little drops of water make the mighty ocean. Similarly, regular savings help in building a large corpus of investments over time. The Systematic Investment Plan (known as SIP) is a popular mode of investing in mutual funds, wherein you invest a fixed amount every month for a fixed tenure. Units are allotted depending on the NAV prevailing on the date of your investment every month.

So, why should you as an individual go in for an SIP compared to lump-sum investment?

Advantages of SIP
Start small: The SIP route allows you to invest as low as Rs.500 per month. You do not have to part a lump sum at one go, making it easier on your purse.
Discipline in investing: Regular savings make you a disciplined investor.
Market timing not needed: As an individual investor, you may be unsure of market movements. SIP investing helps you in averaging costs and reduces risk associated with lump sum investments.
Rupee cost averaging: In SIP, you buy less when the NAV is up and buy more when the NAV is low. This lowers the cost per unit.

Working of SIP
Let’s assume you have Rs. 12,000/- and want to invest this in ABC mutual fund. The Sensex is at 17000. Now consider the following two scenarios:

Scenario 1: You invest this amount as a lump sum in ABC mutual fund, which has an NAV of Rs. 24 on 15th January 2011. Thus, you own 500 units of ABC mutual fund.

Scenario 2: You are unsure of how markets will move and decide to invest Rs. 1,000/- per month, for the next 12 months, starting 15th January 2011. The markets are highly volatile in 2011, and so the NAV of ABC mutual fund fluctuates every month. This is how your investment will look like:

The total number of units you hold at the end of 12 investments is 506.82, at an average cost of Rs.23.67 per unit (Total investment of Rs.12,000/Total units of 506.82). Note that your average cost is lower than the average NAV of Rs.23.71 (Sum of NAVs of Rs.284.6/ Total number of investments of 12) during the period. This is due to the rupee cost averaging concept of SIPs.

Comparison between the two scenarios:

In both the scenarios, you have invested Rs.12,000/-. But you end up holding more units under Scenario 2, compared to Scenario 1. Why is this so?

This is because of the magic of SIP! As the NAV of the fund fluctuated due to volatile markets, there were some months where the NAV was lower than Rs.24 (NAV in Scenario 1). This resulted in you getting more units during that month. So you ended up owning more units in Scenario 2.

But does this magic always work in SIP investing? No, not necessarily!

Disadvantages of SIP

Bull market: When the equity market is expected to go up continuously, SIPs will result in a higher average cost and lower units, compared to a lumpsum investment.

ELSS funds lock-in: Tax savings schemes have a lock-in of 3 years from the date of investment. Under SIP investing, each of your investments is locked in separately for 3 yrs from the date of the respective investment.

So, is SIP as a mode of investment, good or bad?

SIPs are beneficial only if you expect volatility in stock markets, or if you expect a bear phase in the ensuing period. If markets are expected to be bullish, SIPs will not be useful and will result in lower returns compared to a lump sum investment in the beginning. Since it is difficult to predict the direction of the market in the short term, Financial Planners strongly recommend Mutual Fund SIP route for long term equity investments. 

Team “Getting You Rich”