By now, you must be tired of hearing me say why everyone should invest in equity – stocks and mutual funds. Investing in the latter is best done by something called SIP.
If you were to take the usual more often followed route to riches in the stock market, you would probably try to time the market to buy low and sell high in order to make money. However, that is something which we can seldom achieve successfully. Timing the market is strict no no.
The only best way to invest in the stock market is through the SIP or systematic investment plan route of mutual funds.
What is Systematic Investment Plan or SIP ?
This is a method of investing in the stock market by buying mutual funds units – you commit to invest an amount systematically over a period of time instead of investing the money as a lump sum.
It is not an investment avenue and it can be used only with mutual funds. By investing in the SIP way, you don’t care where the stock market is going – up or low – you automatically buys more units of the mutual fund when the stock market is low and less units when it is high. This averages out the cost of purchase – you buy more units when the price is less and less units when the price is more. This concept is called rupee cost averaging.
Let us see with an example how this works.
Consider two investors who want to put in Rs 24,000/- into mutual funds and cash out at the end of 12 months. The ordinary investor decides to put in his money just once in the beginning and cash out at the end of the 12th month. The smart investor, on the other hand, decides to invest systematically the Rs 24,000/- he has. He decided to put in Rs 2,000/- each month into the mutual fund over the next 12 months.
Now the NAV of the mutual fund is going to vary each month in the year of consideration. Let us take a hypothetical varying NAV and check the results.
At the end of 12 months, the ordinary investor has 2400 units and since the NAV of the mutual fund is 11 at the end of the 12th month, his current market value will be Rs 26,400. However, the smart investor has more number of units with him – 2538.91 and at an NAV of 11, his current market value works out to be Rs 27,928.91. Look closely at the varying NAV of the mutual fund and how the units purchased are more when the NAV is less and how the units are less when the NAV is more. The smart investor has more money and has taken less risk to achieve it !
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Following are some of the advantages of SIP.
- They enforce regular disciplined investing in you. You set up the SIP and forget about it. You do not even need to know when the amount is going to be debited from your bank account.
- Rupee cost averaging ensures that your purchase price is less and your risk is minimized. So you don’t have to time the market and lose your shirt.
- SIPs can be started with small amounts, as low as Rs 100/- a month. This ensures they are easy to invest in.
- You can stop, start or modify your SIP anytime.
Other points to keep in mind :
- SIPs fail in an all time rising market. What this means is that if the market were to go up continuously, then investment via the lump-sum route will be better than investing in the SIP way. But the market, over a long period of time, has never consistently gone up or either down – it has oscillated up and down. So for investors, SIP is still the best way to invest.
- A SIP in a badly managed fund will not make you rich – remember that this is a means of investing in the stock market. You need to still pick the right mutual fund and invest in it systematically to make money.
I am a great enthusiast of mutual funds and the SIP investing style it offers. Investors should use it to their advantage. Sure, it does not offer the kick direct stock trading offers, but investors have to decide what’s important for them – the adrenalin rush of direct stock trading with a huge probability of losses or the passive sure shot way to riches style that SIPs offer.