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Systematic Investment Plans (SIPs) offer great benefits to mutual fund investors. We explore the reasons for this and what you must do before investing into an SIP.
If
you remember the childhood
story of the Tortoise and the Hare, then the
Systematic
Investment Plan
(SIP)
is equivalent of the tortoise in the race to create wealth. Systematic
Investment Plans or SIPs as they
are commonly known, offer benefits
while
making sure that you continue moving slowly but surely to win the race
in money
matters. What
is an SIP? SIP,
also known as
Regular Savings Plan (RSP) in some countries, allows you to invest a
fixed
amount at pre defined frequencies in mutual funds. A bank / post office
recurring
deposit is the only other investment option that is similar to SIP.
There are
basically two options that an investor could take when they are making
investments, one would be to invest lump sum into mutual funds and the
other
would be to invest using an SIP. The following are some of the benefits
associated with investing in an SIP: 1)
SIP
enforces investing discipline Many
people have
burnt their fingers and in some case even their
“hands” by investing at will
and on rumours. SIPs
take away the risk from both investing at will and on rumors. As SIPs
require
you to invest periodically and continuously and over time, SIPs make
periodic investing
more of a habit. By regularly investing you tend to be more focused on
achieving your financial goals. This brings in investing discipline. 2)
No
need to time the markets Everyone
in the
market wants to buy low and sell high. This is known as timing the
market. But, the only catch is
we don’t know when to
buy and when to sell. Timing the market
is risky and time consuming process as i)
One
has to do research to identify which stocks are undervalued
and invest
in them. ii)
Even
after investing in the stock, one is not guaranteed of the
returns.
Table
1 shows an
example of a fund’s NAV movement. If you believed in timing
the market, then in
September you would have bought each unit for Rs.8.5 and in November
you would
have sold at Rs. 11.70. This sounds easy in hindsight but the bigger
issue
would be, when you bought into the stock in September: a) You
are not sure when will it go up b) You
are not sure when to sell it With
SIP, the need to
time the markets is taken away due to the concept of Rupee Cost
Averaging. 3) Rupee
Cost Averaging (RCA) Rupee
Cost Averaging
(usually known as Dollar Cost Averaging) is an investment strategy
widely used
by investors all over the world. This calls for you to invest a fixed
amount of
money regularly (on a monthly, quarterly or yearly basis) in a
disciplined manner.
The main benefit of Rupee Cost Averaging is that it takes the guesswork
out of
investing and thereby the need to time the markets. A lot of stress is
avoided
as you do not have to decide whether the fund is expensive or not and
whether
the market condition is suitable to invest. Table 2 shows an
example of
how
more units are acquired when prices are low and vice versa assuming
that you
invest Rs. 1000 every month.
Table
2 shows an example of RCA. If you had
Rs.12,000 to invest, you could choose to invest all of your money (lump
sum) or
invest Rs. 1,000 every month (SIP). If you chose to invest a lump sum
of Rs.12,000
in January, you would have 1,200 units. The cost per unit is Rs. 10. On
the
other hand, if you invest through an SIP, you would have 1,215.8 units
by the
end of December. The cost per unit is Rs.9.87, and hence, the potential
loss is
lessened. From the above example, the return when investing a
lump sum is -17%, the return of the SIP is
-15.9%. One might contend that the period we illustrated in the
examples looked
like a good period to do Rupee Cost Averaging. However, how about
during other
time periods? Would it still make sense to do Rupee Cost Averaging? Rupee
Cost Averaging Works When Markets Are Moving
Nowhere! Let us look at another example of how a better return can be achieved by using the Rupee Cost Averaging strategy, under different market scenarios.
4)
No
entry or exit loads Certain
fund houses
have schemes that waive off entry and exit loads, if invested through
SIPs. Please
note though, that the decision
to waive off entry and exit loads is that of the mutual fund house and
may be
limited to certain schemes only. Waiving off loads for SIPs is not an
industry
practice. 5)
Very
low monthly investments Most
SIP schemes
require you to put in very low amounts. The amounts can be as low as
Rs. 500 to
Rs. 1000 per month and some schemes have even lowered the bar by
requiring you
to pay Rs. 100 only per month. This way, you can do regular investments
and never
feel a pinch in your pocket. 6)
Taxes SIPs
are taxed for
capital gains on first
in first out basis. Consider the values in table
1;
suppose you sold 300 units in February of the next year. Short term
capital gains
will be only levied on the number of units bought in February, March
and April
and not on the units bought in January. Gains from the units bought in
January
will be considered for long term capital gains and not for short term
capital
gains. Some
of the points
you might want to think through before starting an SIP:
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iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's offer document/scheme additional information/scheme information document. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer in the website.
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