SIP or Systematic Investment Plan allows an investor to invest a pre-determined amount at a regular interval (usually monthly). Many a financial advisor and experts consider it the most efficient and convenient way of investing in equity markets.
It allows investors to use their money in an effective manner without worrying too much about market volatility and inculcating a habit of saving an amount every month from what you earn.
In a SIP, an investor’s money is auto-debited from their bank account by their online mutual fund distributor and invested into a specific mutual fund scheme that they opted for. The investment amount buys a certain number of ‘units’ based on the ongoing market rate (called NAV or net asset value) for the day.
As an example, if the NAV for the day is ₹ 5 and your mutual fund investment amount is ₹ 1000, you will be allotted (₹ 1000/₹ 5) 200 units.
Every time you invest, additional units of the scheme are purchased at the market rate and added to your account in the same folio.
Units are bought at different rates and investors benefit from both Rupee-Cost Averaging and the Power of Compounding.
With volatile markets, most investors remain skeptical about the best time to invest and try to 'time' their entry into the market. Rupee-cost averaging allows you to stop worrying about this.
Continuing the previous example, if the NAV for same scheme is now ₹ 10 and your investment amount is ₹ 1000 again, you will be allotted only (₹ 1000/₹ 10) 100 units despite investing the same amount as the previous month.
Your mutual fund investment amount was ₹ 2000 and now your portfolio value is 300 units x 10= ₹ 3000.
Since you are a regular investor, your money fetches more units when the price is low and lesser when the price is high. During volatile period, it may allow you to achieve a lower average cost per unit.
Taking an opposite example, if the NAV now falls to ₹ 1 and you are investing ₹ 1000, you will be allotted 1000 units and your entire portfolio now has 1300 units with the value being ₹ 1300.
When the markets are high again you have the benefit of owning more units which with a higher NAV value could fetch better returns.
Albert Einstein famously said, "Compound interest is the eighth wonder of the world. He who understands it, earns it... he who doesn't... pays it."
The rule for compounding is simple - the earlier you invest, the more your money has time to grow.
If you start investing ₹ 5000 per month on your 35th birthday, in 20 years you’d have invested ₹ 12 lakhs.
Assuming that investment grows at an average of 8% a year, it would give you returns of ₹ 28,63,300 when you reach 55. (Assuming you’re buying Direct Mutual Funds and not paying any hidden annual commissions to your investment advisor)
However, if you had started investing just 10 years earlier, your ₹ 5000 each month would add up to an investment amount of ₹ 18 lakhs over 30 years.
Assuming the same average annual growth of 8%, you would have ₹ 70,88,066 when you reach 55 - more than double the amount you would have received if you had started ten years earlier! (Again, this is if you have bought Direct and not Regular Mutual Funds through your online investment advisor)
The best mutual fund advice you can possibly get from your mutual fund advisor apart from picking which schemes to invest is- buy mutual funds only of the Direct variety to keep your costs low and invest regularly.
Check the Clear Profit Calculator on the Clearfunds home page to see how you can benefit massively from the power of compounding and switching to Direct Mutual Funds.