A systematic investment plan

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A systematic investment plan

Wednesday, 08 August 2018 | Hima Bindu Kota

Investment needs time to grow. The choice of mutual funds should be based on one’s risk appetite and investment objective

A Systematic Investment Plan (SIP) is an investment option offered by mutual funds to investors, where they can invest small amounts periodically instead of lump sums by directly debiting a fixed amount of money from bank accounts and investing in a specific mutual fund and allocating number of units according to the current Net Asset Value (NAV). The frequency of investment could be anywhere from weekly to monthly or quarterly. There is no fixed period of investment in an SIP and it could range from as small as six months to forever. However, shorter the investment period in equity mutual fund SIPs, the higher the potential gain but not without risk. Research shows that there is a 16 per cent chance of losing more than 20 per cent in an equity mutual fund over a six-month horizon, whereas, there is a 90 per cent chance of positive return in an average equity fund SIP of three years or more, making long-term investments more desirable. Although most investors associate SIPs with equity mutual funds, investments into debt SIPS can be as effective.

One of the fundamental principles of investing is to make money work as soon as possible. The longer the money is in the market, the more chance one has of achieving one’s goals. An SIP is an option for small investors who want to take advantage of investing for a longer term but cannot invest a lump sum amount. Surprisingly, sometimes making regular and small investments in the form of SIP can work in the favour of small investors because of a concept known as ‘rupee cost averaging’. let’s take an example. Suppose Ram has a lump sum of Rs 10,000 that he wants to invest in a particular share or fund valued at Rs 100. He has two options: First, he can invest the full Rs 10,000 in one go by buying 100 shares at Rs 100 each. But by doing this Ram is fully exposed to the movements of the market and the value of his investment will rise and fall in line with any share price changes. Second, he can invest his money gradually and may choose to invest Rs 1,000 a month over a period of 10 months. If the share price stays the same, he will be able to buy 10 shares each month at Rs 100. However, since share prices fluctuate frequently, regular investment by Ram will increase his buying power when the share price falls and he will end up buying more shares and vice versa. With a drop in the share price to Rs 90, he can buy 11 shares, whereas if it rises to Rs 110, Ram will end up with nine shares.

The table below shows the effect of rupee cost averaging. By regular, small and pre-determined value of investments, Ram is in a position to buy more shares when the price falls, thereby bringing down the average cost of purchase. When the share price recovers to Rs 100 in the last month, Ram’s original investment is worth Rs 10,300. This means Ram is Rs 300 better off from investing regularly compared to a lump sum investment in the first month by buying 100 shares. However, there is a flipside to it as well. Ram can also lose money if the share price moves up and he ends up purchasing at a higher price for most of the months. However, we all know that stock markets rarely move in a straight line and price fluctuations is the norm. By systematic investments over a period of time, one can invest across a range of prices and effectively end up paying the average price over a fixed period.

Trying to buy an asset when it is considered cheap, which is known as market timing, is tricky even for experienced investors. Just because a share has already fallen steeply in value, doesn’t mean it won’t drop further. Because of many market forces at play, nobody can predict how and when the price will change. The decision to invest should be based upon market conditions and investing on a regular basis through systematic investment plans rather than trying to time a lump sum investment can help one become a more disciplined investor and earn better returns in long run. SIPs help in hedging the risk of getting the market timing wrong. It is also a good option for people with regular income who want to allocate a fixed amount for mutual funds every month.

(The writer is Assistant Professor, Amity University)

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