We have all heard of the term Systematic Investment Plan, more commonly known as SIPs very frequently. In any finance website or magazine, if you read an article about Mutual Funds, the term SIP will come up Invariably. I too have used that term very often, but we have never taken a deep look at what SIPs are and how they are useful to the investors. The purpose of this article is to do just that.
What is a Systematic Investment Plan?
A Systematic Investment Plan is nothing but a regular commitment from an investor wherein the investor agrees to invest a predetermined amount of money regularly (Usually every month) for a predetermined period (Usually 1 year or more).
Simply speaking, a Mutual Fund SIP is like a Bank Recurring Deposit with a difference that, the Mutual Fund will invest in the stock market while the Bank does not do so.
What is the Benefit of taking the SIP Route to Investing?
SIPs are most useful when the stock market isnt on a steady upward trend. In the current economic scenario, the markets are extremely volatile and you never know when the market will go up or down. So, if we choose the SIP route, it gives us the benefit of "Cost Averaging". In other words, since you are investing every month, you can take advantage of any dips in the stock market and accumulate additional units. This way, at the end of the SIP Period, you will end up with more units that what you would have accumulated if you had invested in one shot.
More importantly, parting with Rs. 5000/- every month may not look that difficult, but if you are asked to cough up Rs. 75,000/- in one month that will sound like a lot, wouldnt it? That is exactly why SIPs are easier than one time investments.
A Real Life Example:
Let us say Mr. X invests Rs. 75,000/- in ICICI Prudential Focused Equity - Dividend Plan on the 5th of January 2011. His best friend, Mr. Y feels that the SIP Route is the best way to go and signs up for an SIP for Rs. 5,000/- for a duration of 15 months that works out to the same Rs. 75,000/-. Let us now compare what happened...
Mr. X - The One-Time or Bulk Investor:
NAV As on 5th January 2011 = Rs. 17.11 per unit
Units Accumulated through One Time Investment of Rs. 75,000/- on 5th Jan 2011 = 4383.4 units
NAV As of 4th April 2012 = 15.68
Value of Investment as of today 4th April 2012 = Rs. 68,731.74/-
Dividend Income on 25th January 2011: Rs. 3287.55 (The Fund declared a Dividend of Rs. 0.75/- per unit on 25th Jan 2011)
Net Value of Investment as of 4th April 2012 (Including Dividends) = Rs. 72,019.29/-
Net Loss = Rs. 2,980.71/-
Mr. Y - The SIP Investor:
Below is a table that outlines the investments every month.
|Date||NAV||Invested Amount||No. of Units|
Total Amount Invested in 15 months = Rs. 75,000/-
Value of SIP Investments as of 4th April 2012 = Rs. 77,239.19/-
Dividend Income on 25th January 2011: Rs. 219.17/- (The Fund declared a Dividend of Rs. 0.75/- per unit on 25th Jan 2011)
Net Value of SIP Investments as of 4th April 2012 (Including Dividends)= Rs. 77,458.36/-
Net Profit = Rs. 2,458.36/-
So, the Winner is "Mr. Y". As he chose the SIP route, he ended up making a profit of Rs. 2,458.36/- over the past 15 months on his investment of Rs. 75,000/- while Mr. X ended up making a loss of Rs. 2,980.71/-
How did Mr. Y defeat Mr. X?
The Stock Market throughout the year of 2011 was very choppy. If you see the NAV movement, it was going up and down on a regular basis. It was down in February, went up in March & April, Came back down in May and so on. Since Mr. Y, invested every month, he was able to take advantage of this movement and accumulated more units on months when the market was down. This way, he ended up accumulating more units than Mr. X. Since, all MF Investments are in units, as Mr. Y held more units than Mr. X as of today, his investment beat his friends.
Is SIP always the best investment option?
Actually No. It is the best option in choppy markets. Today, the BSE Sensex is in the 17600 range. Let us say it reaches the 21000 levels by end of the year, do you think that Mr. Y will beat Mr. X? Definitely NOT. Mr. X will beat Mr. Y hands down. So, in a bull market, a one time investment will beat an SIP because, the NAV is going to keep rising every month and you will end up accumulating lesser units every month. In such a scenario, a one time investment makes more sense.
As of the current market scenario, the SIP won the battle and remains the winner. Until the Bulls start running in Dalal Street, it is better to trust the SIP than a one time Investment.