SIP: The Smart Way to Invest in Mutual Funds
Updated: Jul 2, 2019
“Rome was not built in a day." And perhaps neither is financial success! The wisdom underlying this famous french proverb is as true for creating long-term wealth as it is for building cities. Let us try to understand this comparison by assessing the merits of investing in financial securities through Systematic Investment Plans (SIPs).
To put this in perspective, consider a situation where you are looking to build long-term financial security and have decided to invest in a diversified pool of assets. You are evaluating investing through mutual funds but are confused about the timing - should you invest in a rising market or wait for a correction? While investing in a rich market could expose your portfolio to downside risk, waiting for a potential decline may cause you to miss out on the investment in itself!
So, how does one decide on the right time to invest? Though there are no exact solutions to this puzzle, an intelligent approach for neutralizing this dilemma would be to invest via a Systematic Investment Plan (SIP).
What is a Systematic Investment Plan?
A Systematic Investment Plan or “SIP” is smart way to invest money in mutual funds. A SIP allows you to invest a certain pre-determined amount at regular intervals (monthly, quarterly, etc.) in your chosen mutual fund scheme. It is a disciplined approach to investing which protects you from the volatility of the stock markets and helps you develop a habit for saving and investing.
How SIP works?
Investing in a SIP is easy. An investor simply needs to fill an application form and a SIP mandate form to indicate one’s choice for the SIP date (the day on which the amount will be invested). On the chosen date, a certain predetermined amount will be auto-debited from the bank account through ECS (monthly or quarterly depending on the chosen time interval) and a certain number of units will be allocated based on the Net Asset Value (NAV) of the fund on the given day. Every time one invests, additional units of the mutual fund scheme are bought at the given NAV and added to the account. Therefore, units are bought at different rates at different intervals, thus addressing the issue of market timing.
Benefits of SIP
1. Rupee-Cost Averaging – Rupee-Cost Averaging eliminates the need to time the market. With rupee-cost averaging you invest a certain amount at regular intervals irrespective of the Fund’s NAV. As a result your money buys more units at a lower price and fewer units at a higher price. This implies that irrespective of market volatility it is possible to achieve a lower average cost per unit.
2. Power of Compounding - In the words of Albert Einstein, “Compound interest is the eighth wonder of the world. He, who understands it, earns it ... he who doesn't ... pays it”. A SIP is a powerful tool to reap the enormous potential of compounding over time.
Suppose you start investing at the age of 40 and invest Rs 20,000 per month for the next 20 years. In 20 years’ time you would have invested Rs 48,00,000. Assuming your investments earn 12% per annum, it will be worth Rs 1,97,85,107 by the time you turn sixty.
Now, suppose you start investing at the age of 30 instead of 40 and invest Rs 20, 000 per month for the next 30 years. In 30 years’ time you would have invested Rs. 72,00,000. Assuming your investments earn 12% per annum, it will be worth Rs. 6,98,99,283 by the time you turn sixty.
So a head start of 10 years makes you richer by more than five crore rupees. Let’s look at the comparison in the following chart:
The sooner you start investing, the more time you money has to compound and grow.
3. Disciplined Saving: The key to long-term wealth creation is discipline. SIP ensures that you do not get scared by market volatility and develop a long-term habit of disciplined saving crucial to your long-term investment success.
4. Flexibility: Investing in SIPs is very flexible. You can discontinue at any point in time although usually it is not advisable in lieu of long-term wealth creation. Most schemes also allow you to increase or decrease the amount of investment depending on your needs and strategy.
5. Liquidity: SIPs also provide high liquidity. An investor may enhance the liquidity of his investment by choosing open ended Mutual Fund schemes which allows you to redeem all or part of your investment at any time and receive the current value of your investment.
SIP is a hassle-free mode of investment for most people who lack adequate market knowledge and do not have sufficient time at their disposal to pursue active investing. Investing via SIP protects you from vagaries of the market, compounds your money over time and ensures that you develop a disciplined saving habit critical to achieving your long-term goals.