Investing through SIP

Post the volatile years of 2008 and 2009, financial advisors and mutual fund companies have started promoting Systematic Investment Plans (SIP) as a safest way to invest in equities.  No doubt SIP is one of the best ways to invest your funds, but you need to do your homework better to ensure that you make full use of its potential.

                        Also read: Your guide to mutual fund investments

What is SIP and how it works

SIP is an investment strategy in which one invests a fixed sum of amount periodically for a specific period.  In SIP, you mandate your fund house to invest a fixed sum on a fixed date for a fixed period.  The mandate can be given either through standing instructions or through post-dated cheques.  SIP can be started for an amount as low as Rs. 500 a month and there is no upper limit.  You need to choose the date on which you want to invest.  Generally the fund house gives you the option from which you can choose the date to invest. For example: HDFC Mutual Fund provides option to choose from 1^st, 5^th, 10^th, 15^th, 20^th or 25^th of every month.  Instead of monthly investment, there is an alternative for quarterly investment.  Further few mutual funds provide Daily Investment Plans (known as DIP) where one can invest daily instead of monthly.  The minimum period of investment can vary from 6 months to 12 months depending on the scheme you choose.  The period can be extended by providing additional post dated cheques or standing instructions.

How it creates wonders

The benefit from SIP is due to the fact that irrespective of what the market is, you keep investing fixed sum regularly.  This works to your benefits since at the time of rising market, you purchase less number of units of a fund; whereas in falling market you purchase more.  This is similar to an age old investment advice of buying when others are selling and selling when the others are buying.  Let us run an example to clarify this further.

Suppose you start a SIP of Rs. 5000 per month in Jan 2010.  You decide to invest on 5^th of every month for next twelve months. Let’s see how your sum gets invested.

  

The blue line is the movement in nifty index from January 2010 till date and the green bars are the number of mutual fund units purchased each month for SIP of Rs. 5000.  As can be seen from above graph, the largest number of units are purchased in the month of Feb 2010 when the index was lowest, whereas when index started rising from June 2010, the number of units keeps on reducing.  In other words, you are purchasing lesser number of units when the price rises and more number of units when the price falls.

This is one of the main advantages of SIP.  You keep on investing a fixed sum every month irrespective of the market movement and the cost averaging during high and low peak works in your favour.

In my next post, we shall discuss about the other advantages of SIP, times when the SIP does not works (yes, sometimes it is not beneficial to start an SIP) and what important things to consider before starting a SIP investment.  Nowadays advisors have started fooling investors in SIP. Hence you should not blindly start a SIP.  More on this in the next post.

Till then share your comments and suggestions on this article.  Thanks.