It is often quoted that regular savings, even if they are small, help in building a huge corpus over a long period of time.
The Systematic Investment Plan (popularly called SIP) is a way of investing regularly in mutual funds. The investor invests a fixed amount at regular intervals for a fixed tenure, to be chosen at the time of investment. The periodicity of investment depends on the mutual fund.
Most mutual funds allow SIPs on a monthly basis, while there are some funds which allow SIPs even on a quarterly basis. The NAV prevailing on the date of your investment every month determines the units to be allotted.
A high NAV results in fewer units allotted and vice versa.
How does an SIP work?
Suppose you have R60,000 and wish to invest this in a mutual fund. Let?s assume that the Sensex at the time of your decision is at 18,000. Let?s look at the following two cases:
Case 1: You invest this amount as a lump sum in an equity mutual fund, which has an NAV of R60 on January 20. Thus, you own 1,000 units of the equity mutual fund.
Case 2: Instead of investing the entire amount in one shot, you decide to invest in an equity mutual fund in the form of a SIP every month. Let?s say you invest R5,000 per month for the next 12 months, starting January 20. Assume that the markets are highly volatile over the next 12 months, resulting in the NAV fluctuating every month. This is how your investment will look like:
You own 1,006.17 units of the mutual fund at the end of 12 investments purchased at an average cost of R59.63 per unit.
In both the cases, the total amount invested is the same, at R60,000. But you hold more units in Case 2 compared to Case 1. This is because the fluctuation in NAV of the fund due to volatile markets resulted in some months witnessing an NAV lower than Rs 60 (which is the NAV under Case 1).
As a result of this, you were allotted more units during these months, compared to the months where the NAV was higher than R60. Consequently, you had more units under Case 2.
The main question to be addressed is if this wonder of SIP works in all scenarios. The answer is that it does not necessarily work in your favour all the time.
So, should you opt for the SIP mode of investment or not? Let?s look at the benefits and drawbacks of SIP investing before answering this question.
Benefits of SIP
Disciplined investments: When you save and invest regularly, you become a disciplined investor. As there is a forced commitment towards investment, you also watch out and cut back unnecessary expenses during the month.
Large investments not needed: Under the SIP route, you can invest even small amounts, which can be as low as R500 per month. As the investments are small and there is no need to set aside a lumpsum, it is easier on your wallet.
Rupee cost averaging: When you invest through SIPs, you get more units when the NAV is low and fewer units when the NAV is high. As a result, your cost per unit is lower than the simple average NAV during the period. This is known as rupee cost averaging, which is beneficial to an investor.
No need to time markets: A retail investor is generally unsure of market movements, and is unable to benefit from such moves. He may also not have the time to monitor his investments regularly. In such cases, SIP investing helps you in averaging costs and reduces risk related to lumpsum investments.
Drawbacks of SIP
Not suitable in a Bull market: An SIP will result in a higher average cost and fewer units compared to a lumpsum investment if there is a bull phase in the equity markets which results in higher NAVs every month.
Lock-in period in ELSS funds: ELSS funds have a lock-in period of three years from the date of investment. An SIP investment entails each of your investments being locked in separately for three years from the date of the respective investment.
Given the positives and negatives, when should you opt for an SIP investment? You can benefit from SIPs only if you anticipate a bear run in the market or volatile markets during the proposed tenure of investment. SIPs should not be selected if markets are expected to be bullish, as they will result in lower returns compared to a lumpsum investment.
