An Outline of Systematic Investment Plans

SIP (Systematic Investment Plans) is something we hear a lot. We even shake our heads in agreement with the mutual fund sales man who keeps telling us about the merits of SIP. However, the reality is that most of us are ignorant about Systematic Investment Plans.

Systematic Investment Planning and Rupee Cost Averaging

Systematic Investment Planning is an investment technique in which we make small payment to a mutual fund at regular intervals. This is beneficial for those who wish to invest in high return avenues (like shares), but do not have lump sum money to put in. Through SIP, they can slowly increase their investments and reap profits just as other investors.

This kind of investment also benefit from Rupee Cost Averaging (RCA).  We pay a fixed amount at a regular time interval under SIP. The price of shares is different at different time. So when the price is lower, with the same amount of money we can buy more number of shares and when the price is higher the number of shares bought is lesser. This actually brings down the average cost per share.

Rupee cost averaging can be explained by an example. Say you are planning to invest as SIP an amount of Rs. 12,000. For that you make a payment of Rs. 1,000 per month.

Suppose your fund manager decides to buy company A’s share which is trading at Rs.10 for a total of Rs. 1,000. At the present price you can buy 100 shares. However, when you make your second payment imagine that the price of company A’s share is lower at Rs. 5. Then with Rs. 1,000 you can buy 200 units of the company A’s shares. Again on your third installment, say the price of share is high at Rs.20, fetching you only 50 shares.

Now you have a total of 350 shares of company A in your portfolio, which you bought for Rs. 3,000. The average buying cost per share is around Rs. 8.50. When you plan to sell of the shares, say when price is Rs.15, your profit margin is increased as the buying cost per share is low.

However if you had spend the whole Rs. 3,000 at one go you would have been forced to buy shares of company A at the price of Rs. 10 per share. This means that you would then only have 300 shares of the company. You would have missed the chance to buy the shares for a lower price, thus reducing the profit margin in the eventuality of selling them.

This is rupee cost averaging and it can work best for you if you invest in multiple shares through systematic investment planning. A Mutual Fund offers the perfect avenue to execute SIP in diverse equities.

Benefits of SIP

SIP Works for Everybody: This type of payment works well for every one regardless if the person is a small retail investor or a high net worth investor.

For a small investor, she gets to benefit as she need only pay a small amount at regular intervals for investing in high performing equities. She can also benefit for rupee cost average to maximize her limited investments.

In case of a high net worth individual the goal of SIP is to profit from the market price fluctuations, leveraging them to make best out of their investments from a volatile marketplace.

Pay as you wish: With SIP, skipping a payment doesn’t invite any penalty. SIP is a mode of investing, if you don’t pay a month, you just loose the opportunity to invest at that time. If the market is extremely bullish, then you can opt out of that month, without paying any fine. This gives you ample freedom to invest the way you want. However, it is wise if we make our payments regular to reap the full benefits of systematic investment planning.

SIP works in Portfolio: Because mutual funds invest in a collection of shares and not in a single share, the chances of making profits are more and risk of loss is less. If we had invested in a single share instead of a portfolio, our risk is higher because if the price of that share go down continuously, we will loose our investments. However if our portfolio contains several shares then loss in one share can be balanced with profit from another one.

Minimum Payment in SIP is Low: A person can invest in a SIP with limited amount. There are SIPs which requires only Rs. 500 each month. For a person with low income she can set aside a small amount to invest in a SIP. This helps her to grow her investments over time. The strategy here is simple: Slow and steady wins the race.

Long Term: We can continue SIPs for a long time. This will help us to gradually build our portfolio investment. In the long run returns start to come in and we can reinvest it in our SIP for further growth of the investment fund. You can thus make the power of compounding work for you.

Chances of Making a Profit Higher with RCA: As explained earlier, we can make more profit through Systematic Investment Planning by applying the rupee cost averaging to our benefit. If we invest through SIP we buy more shares of the company when the price is lower, which is the best time to buy. At larger price we avoid buying these shares. Therefore automatically we tap into the market mentality to make the maximum profits. The profit is usually smaller if you are buying at one stretch.

Waiting for the ‘best time to buy’ is Ruled Out: Often we are afraid to put in money in equities, as we keep waiting for the best time to invest. When markets are on a high, we lack enough funds and when markets are low, we wonder if investing will be a loss. SIP opens the door to invest in equities, immaterial of the market situation. As a long term investment, SIP eventually fetch you good profit from the fluctuating prices.

Exit Plan for SIP: SIP can be treated as a means to attain any of your financial goals. This disciplined investing method works well for people planning to generate a lump sum over a period of time by investing small amounts.

Limitations of SIP

Investing in SIPs during rising markets is not a good idea. This is because rupee cost average works against us. The average cost of share is high during such periods. We will end up with less number of shares for the given amount of money. Therefore we cannot make enough profits.

Make sure that these mutual funds are run by professionals with a good track record. If fund managers are not genuine the fate of our investments lies in the balance. Inexperienced managers are not aware about the volatilities of the market, and lack knowledge on how to profit from it. In such situations they may do reckless trading in order to gain returns. This will be counter productive and puts our investments at risk.

Though there are limitations for investing by way of SIP, the benefits are loud and out numbers the limitations. At the end of the day a systematic investment planning helps us to build up an investment which will definitely help us in the long run.

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