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The Importance Of Consistent Investments: Sips
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Most investment planners and advisers stress on the importance saving and investing regularly – even if it is in small amounts. Systematic Investment Plans (SIPs) are aggressively marketed by mutual funds and for once, I would say that this strategy is justified and welcome. Based on personal experience, I can assert with confidence that systematic and regular investments in a mutual fund scheme over a period of years is one of the best ways to grow your money, especially if you are averse to investing directly in equities but want higher returns than that offered by fixed deposits or other debt instruments.
On this site we have talked earlier about how small quantities of money, saved over a period of time, accumulate into large amounts. SIP is based on the same principle.
What is a SIP?
Under a systematic investment plan (SIP), an investor commits to investing a specified sum of money periodically (daily, weekly, monthly, quarterly etc.) in the units of a mutual fund scheme. You can invest in equity schemes, debt funds, money market schemes and in exchange traded funds.
It is usually convenient to invest regularly on a previously specified date and that amount can be automatically debited from your bank account by an arrangement with your bank. The prevailing price of the units on the date specified by you will apply and the number of units purchased will depend on that. The inherent advantage in a SIP is that it averages out your purchase price over a period of time and you do not have to bother about timing the market.
There is a variation on this kind of purchasing – you can buy units in a scheme of your choice on days when the market is falling. This way you can ensure that, you are buying when the cost is low. Of course, that would mean monitoring the market on a daily basis. If you are a smart investor, you can opt for market alerts or even NAV alerts on your mobile so that you know when the market is falling with a minimum effort on your part.
In order to make SIPs as attractive as possible many mutual fund schemes allow investments as low as Rs 500 a month. You can set aside a sum of money, which you feel you can afford after accounting for all your expenses and debt obligations. In fact, funds sometimes charge a lower entry load for SIPs than for normal investments.
When is a SIP advantageous?
It has to be understood by investors that SIPs work only when you do it over a long period of time. I would suggest a minimum period of three years for you to get the benefit of optimal returns. During that period, you will have to content with ups and downs in the markets – whether it is debt or equity. But the advantage is that when the market prices are low, the NAV of the units will also be low and you will get more units for the same units. You will realise the benefit of this when prices rise.
Let us try and see with examples how falling and rising markets affect your SIP
Suppose you have decided on a SIP, investing Rs 1000 per month for the next 12 months. For convenience’s sake, we will make it an equity scheme.
Scenario-1 (When prices are declining):
Assume that the price per unit is Rs. 15 for first 8 months and Rs 10 per unit for last 4 months.
Every month, for the first eight months you will be buying 66.67 units. So in the first eight months you would have bought 533.33 units.
In the last four months when the prices have dropped to Rs 10 a unit, you would be buying 100 units a month and that makes it a total of 400 units in four months. So at the end of 12 months, you would have accumulated 933.33 units with an investment of Rs 12,000.
At the end of the 12 months, you decide to redeem the units. Now suppose the price has further fallen to Rs 9 a unit when you redeem it. You would get Rs 8,399.97 on redemption.
This means that you make a loss of Rs 3600.03 on your capital. This is because the value of the units fell from Rs 15 in the first eight months to Rs 10 in the last four months and by a further rupee when you decided to redeem it.
Scenario-2 (When prices are rising):
Now we will take a scenario when prices of the units are on a rising trend. You have decided to invest Rs 1000 a month for 12 months in an equity scheme. Now the prices of the units are Rs 10 in the first eight months and fall to Rs 15 in the last four months.
At Rs 1000 a month investment, you buy 100 units every month and 800 units in eight months. In the last four months, you buy 266.67 units. So the total number of units bought by you is 1066.67 with a capital of Rs 12000.
After the 12 months are up, you decide to redeem your units and the price has risen by a rupee to Rs 16 a unit. Your redemption amount will be 17,066.72 and you would have made a neat profit of Rs 5066.72 on your investment.
In real life, the prices fluctuate every day and would not remain constant every month. The advantage of a SIP is that regular investment at periodic intervals ensures that your cost of acquisition remains low or at least reasonably low. If you want to be really clever then you would take the trouble to buy when the prices are on a decline and sell when they are rising. Also, you should always allow at least three years for your SIP investments to accumulate to a significant amount and give you the returns that you are looking for.
One thing you have to understand is that there is no right time or wrong time to start a SIP. Since you will be investing over a long period of time, ups and downs will be balanced out. It is not like an equity investment where you have to buy low and sell high, since these are mostly one-time investments. (You can also make regular investments in stocks directly and follow the same investment pattern that you would with a mutual fund scheme to get maximum return at reasonable costs.)
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