Systematic Investment Plan or “SIP in mutual funds” is a method to invest fixed amounts of money into a mutual fund on a periodic basis. Generally, investments are done on the daily, weekly, monthly or quarterly basis on a fixed date. Monthly and quarterly SIP in mutual funds is the most common ones however; daily SIP in mutual funds are also becoming popular.
So how does a SIP in mutual funds work? Well, units of mutual fund will be bought into the investor’s account for a fixed amount and on a fixed date (chosen by the individual) at the available price or Net Asset Value (NAV).
Example: Suija has opted for the SIP option of Rs 2000 on every 5th of the month. Thus, on 5th of every month, mutual fund units worth Rs 2000 will be bought in Suija’s account.
Equity diversified funds are the preferred mutual funds however, many fund houses offer SIPs on Debt or Balanced funds as well.
Fundamentals of SIP
SIP in mutual funds is based on 2 most strong fundamentals of finance;
- Rupee Cost Averaging
- Power of Compounding.
1. Rupee Cost Averaging
Rupee Cost averaging means buying into anything, in this case, security like stocks or mutual funds at fixed intervals of time irrespective of the price. At lower prices, you would end up buying more units and lesser units at higher prices. Thus, the price per unit averages out over a period of time. This is one of the main underlying principles of SIP.
Let’s look at the following example to understand this in depth. Kay invests Rs 5000 in HDFC Midcap Opportunities on the 5th of every month for 1 year.
Based on the NAV of the mutual fund on 5th, he will receive certain number of units.
Following graph gives a pictorial view of the same-
In the graph above, more number of units are received when NAV is low and vice versa. We can see that, although NAV is sometimes above 5, the average NAV works out to be 4.83 as it averages out over a period of 12 months.
Buying mutual fund at lowest NAV is not always possible especially for retail investors as timing the market is difficult with the limited knowledge that he/ she has.
Thus, by investing through SIP in mutual funds, one can take advantage of the Rupee Cost averaging. The longer the duration of investment, more are the benefits of Rupee cost averaging.
2. Power of Compounding
This is 2nd most important reason for SIPs being preferred as long term investment instruments. The earlier you invest, more wealth you accumulate. This is the Power of compounding. In addition to the principal amount, the interest earned is also compounded.
Look at the example below. If Shri starts investing Rs 10000 through monthly SIP in mutual funds for 15 years, he will save Rs 50 lakh assuming a growth rate of 10% per annum.
See the following screenshot for a 15 year investment
In the pie chart, we can see that the interest earned is almost double of the principal amount. Thus, small amount of investment made regularly on a monthly basis can lead to substantial savings in the long term.
Duration of the investment can make a lot of difference.
In the graph below, we can see that the same above investment i.e. Rs 10, 000 invested at 10% p.a. for 25 years, which is just 10 more years, increases the savings by a whopping 3.5 times !!!
That’s the power for compounding
See the following screenshot for a 25 year investment:
Disadvantages and Advantages of SIP in mutual funds
Having spoken about the fundamentals, it’s time to look at the Pros and Cons. Good things first-
Advantages – of SIP in mutual funds
1) Lower minimum investment
SIPs generally start at a minimum investment of Rs 500.
2) SIP makes you systematic
In SIP, you would be required to give post-dated cheques or Electronic Clearance instructions so that a fixed sum of money gets transferred from your account for being invested in an SIP. Whichever payment method you use, on a regular basis the money will be invested in the mutual fund, without you having to worry about it every month.
3) Flexibility of dates
There is flexibility of dates one can opt in SIP. So, an investor can have his or her leeway to arrange for the necessary funds on the day of the fund.
4) Ease of Investing
As with all mutual funds, one can invest in SIP through financial intermediaries or by use of internet as well by filling a simple form. As I mentioned earlier, you will need to give post-dated cheques or ECS instructions.
5) Helps Reach Financial goals
SIP can be used as a means to reach long term financial goals like marriage, Child’s education or any such goals.
6) Save small amounts to make big investments
Even Rs 500 saved every month for 20 years can lead to huge savings. Add to that the market movement and it is a sure shot way to gain maximum benefits in the long run.
Disadvantages – of SIP in mutual funds
All good things come with a tinge of drawbacks. So, does SIP in mutual funds. Here they are-
1) There are no assured returns as the returns depend on the performance of the market.
2) SIPs are more suitable for long term investments so that one can take the advantage of market movements. In short term, you might actually end up losing money rather gaining.
3) SIPs have limited date options like 1st, 5th, 10th, 15th, etc. Hence, one would end up investing in SIP on the same dates in multiple mutual funds.
4) Stopping the SIP for any particular due to constraints of funds or any other reason can be cumbersome.
5) Since a fixed amount needs to be invested every month, individuals with unpredictable cash flows can face a problem.
A Word on Daily and Weekly SIP
While monthly SIP in mutual funds is the most preferred investment plan, many fund houses have also introduced daily or weekly SIPs.
Daily SIP in mutual funds invests on all days the stock market is open which is about 19 to 21 investments in a month while weekly SIP would invest on a particular day of every week i.e. around 4-5 times a month.
Daily SIP in mutual funds works better in a highly volatile market as one can take advantage of the price movements. Also, in case one wants to invest a lump sum, it can be split into smaller amounts and invested on daily basis in the market to take advantage of the price movements.
However, it has its limitations as keeping track of 20 transactions in a month can be pretty cumbersome. Like the name suggests, SIP make you systematic. So Happy Investing!!!!