A journey of a thousand miles begins with a single step - Lao Tzu
SIP stands for Systematic Investment Plan. It is a investment technique or strategy. In SIP, an investor invests a fixed amount at a regular intervals in mutual funds, stocks, etc i.e. investor believes in one step at a time. It is analogous to Easy Monthly Installments (EMI) but the difference is that here you are investing to grow your capital and in EMI you are paying the debt, loan, etc. For example, Rahul starts a SIP of Rs. 5000 every month in SBI Bluechip Mutual Fund. In first week of every month Rs. 5000 will be automatically deducted from Rahul's account and will be invested in the particular mutual fund. SIP is very popular in mutual funds and slowly gaining popularity for stock portfolios as well.
Why SIP ? The main advantage of investing with SIP is that you don't need to time the market. Similar to our life, markets also have ups and downs i.e it does not move in a straight line. An investor hopes to get the best price and get the best profit i.e buy at lowest price and sell at highest price. Unfortunately, it is very hard to predict the high and lows and many have lost fortunes in timing the market. Hence, via SIP no matter what the cost is i.e high or low, investment is done systematically. We also call this Rupee Cost Averaging. For example, look at the below SIP investment for 6 months.
For this investment, 1100 units of MF were purchased for Rs. 30,000 over 6 months i.e at average price of Rs 27.27 (30,000/ 1100) per unit. Following is a chart of a mutual fund NAV for 12 months.
*chart is not real and is for explaining the example.
Remember if you would have invested Rs. 30,000 as lump sum in month of September , its value would have dropped to Rs. 18,750 (25/40 * 30,000) in December. Another advantage is the availability of liquidity. Most of the people get income from their monthly salary. Instead of keeping it as cash and losing its value due to inflation, one can use part of his/her monthly income as a SIP in a mutual fund. This automated system, causes a disciplined action and avoids the psychology and emotions of humans.
Let's look at the possible cons as well. Having a short term goal with SIP can hamper your returns. For example, investors who started investing in mutual fund in 2017 (peak), have seen the depreciation in principal value in 2018, 2019, 2020 due to slowdown in economy and covid-19 pandemic. If one stops here, one has to book the loss. Therefore, it is important to have at least 3-5 years of goal with SIP investment. Another con is the transaction charges i.e more frequent bets, more are the transaction charges.
Net Profit% vs Internal Rate of Return. It is important to know the difference between these 2 things, if you are investing via a SIP. Let's take an example to understand this well. Rahul invests Rs.1000 for 15 months i.e Rs 15,000 via SIP in a mutual fund and books a profit of Rs. 18,000.
Net Profit is simply (Sell Price - Cost Price) i.e Rs 3000 and profit % is 20% (3000/15000).
Note that the period of investment is different for every monthly investment. First monthly investment was for 14 months, second for 13 months, third for 12 months, and last investment for 0 months. Hence, returns are to be adjusted as per the period of investments. This is all considered in internal rate of return. By calculation, the internal rate of return is ~35.5%. Therefore, rate of return can be considered as ~35.5% instead of 20%.
As SIP has multiple entry points (regular investments) and multiple exit points (withdrawals) in investment journey, it is wise to calculate Internal Rate of return and not CAGR or Net Profit.
In conclusion, an investor who does not want to spend time in following markets, wants to follow a systematic path of regular investment and has a long-term horizon should definitely start a SIP. A minimum SIP investment required in mutual fund is Rs. 500 only.
Thank You.
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