Stock markets all over the world are prone to volatility which is proved by the movements in stock markets in the past. Investors invest in stock markets with some objective in mind. In doing so, there is always a dilemna in investors' mind that ponders over the right time to invest. Many investors keep waiting for the markets to come down and a lot of times, markets move in just the opposite direction leaving such investors with no option but to keep their money idle or to invest at even higher levels.
Concept of Systematic Investment Plan (SIP)
Just like banks and Post office offers recurring deposit schemes, mutual funds offer an SIP option. Investors opting for an SIP option commit investing a pre-specified sum of money at regular intervals (generally every month) in a particular mutual fund scheme. Each periodic investment entitles investors to recieve units of that mutual fund scheme, which is subject to its NAV prevailing at that time.
Working of SIP
Let us take an example to understand how an SIP works.
Suppose 'X' decides to invest in a mutual fund through SIP. He commits making a monthly investment of Rs 1000 for a period of twelve months (starting 1st January 2006) in a fund named 'ABC'. The payment can be done by issuing twelve post-dated cheques of Rs 1000 each or through ECS facility (if available).
|Number of Units
Monthly Investment: Rs. 1000
Period of investment: 12 months (1st Jan 2006 to 1st Dec 2006)
Total amount invested: Rs. 12,000
Total number of units credited to 'X': 194.925
Average cost/unit: Rs 61.5621
Entry and exit loads are applicable while investing through SIP option also. However, in this example, load has not been taken into consideration for the purpose of simplification.
Benefits to 'X'
Convenience and affordability because of an easy payment method
Helps X to develop the habit of disciplined investing as he/she is compelled to fulfill his/her commitment of making a fixed payment every month
Rupee cost average benefit - By investing through the SIP route, 'X' recieves 194.925 units at an average cost of Rs. 61.5621. However, had 'X' invested the whole of Rs. 12000 at one go, he would have recieved a different number of units. Suppose 'X' had invested Rs. 12000 on:
1st Jan 2006 - He would have recieved 259.24 units
1st Jul 2006 - He would have recieved 193.11 units
1st Dec 2006 - He would have recieved 133.45 units
Since, it is not so simple for anybody to perfectly time the market, it makes a more sensible approach to invest through SIP option (for long-term, say 3 to 5 years). It actually makes the volatility in the stock markets work for investors. This example helps us to understand how SIP allows 'X' to take benefit of all the highs and lows of the market during this twelve months time period.
Flexibilty to redeem units at any time or making a change in the monthly investment amount
Advantages of SIP
Rupee cost averaging - SIPs are based on the concept of Rupee cost averaging. It helps investors to limit their purchases in rising markets and expand them in falling markets. It helps to tap the tops and bottoms of a stock market thus averaging out the cost per unit of a mutual fund scheme (see example given above).
Disciplined Saving - SIPs play a vital role in helping us improve our investment habits. It reminds investors of their commitment to contribute a specified amount to the pool at regular intervals. This makes investors more disciplined in their approach towards investment which finally helps them in saving more money (as this monthly investment could otherwise be used for spending on unnecessary items).
Compounding Benefits - Because of the power of compounding, investors who start early get the maximum advantage. SIPs have provided maximum returns when investments are made for a long period of time (i.e. for 3 to 5 years) and investors who follow this strategy gain from the compounding effect of returns on their investments.
Risk-free from Timing - Many invetors try to time the market and faill most of the time for the simple reason that it is virtually not possible for anybody to time the market. SIPs enable investors to capitalise on upside and downside movements in the market and be care-free from the tedious task of timing the market. Investors opting for SIPs don't need to worry about the daily movements in the market.
Disadvantages of SIP
No downside Protection - Investors should remember that despite of all the advantages that SIPs have, they are subject to market risks and do not protect investors from making a loss or ensure them profits in falling markets.
Portfolio risk remains - SIPs are also subject to security risk. Mutual fund schemes investing in portfolios that turns out to generate negative returns are bound to make investors incur a loss even if the investment is made through SIPs.
Ideal Profile of Investors
Investors opting to invest through an SIP option should:
have a long-term investment horizon,
be willing to invest regularly,
keep patience, and
who can not invest enough amount at one go
Before opting for SIPs
SIP option is available for all types of funds. This arises the need for investors to do a little homework in order to get the maximum returns out of their investment.
Defining the investment objective
Investors should invest with a clear objective in their mind. It helps to figure out an indicative time period for which the investments would have to be made.
Determining the investment surplus
Investors should estimate the amount that they can afford to invest on a periodical basis. Investors should be conservative while making this estimate as an over estimated periodical investment amount may turn out to be a burden for investors.
Matching periodicity to fund flows
SIPs are available in monthly and quarterly options. Investors should opt for an option that is in tandem with the periodicity of cash inflows.
Selecting an appropriate scheme category
Before investing investors should take the risk- return profile of a scheme into consideration. Investors should choose a scheme that suits their investment objective. For example: Equity funds are recommended to investors who have a high risk taking capacity, debt funds for risk-averse investors and balanced funds for investors with moderate risk taking capacity.
Performing fund manager
All fund schemes are managed by a fund manager. Investors should select a scheme which is managed by a proven and successful fund manager. However, past performances do not assure good returns in the future, but do form a basis for decision making.
Ignore the market swings
In the short term, sentiments drive the movements in the market. Therefore, investors shold not let a short term correction or fall in the markets to bother them. As long as the long term prospects are intact, the investments are safe.
Periodical review of investments
After selecting an appropriate scheme and making investment in it, investors should continuously monitor the performance of similar schemes to the one in which the investment is done. This enables investors to compare the performance of their scheme with corresponding schemes and make necessary adjustments, if required.