This is the market revolutionary change happened, achieved fame and many of us heard of it without knowing much about it.
Unfortunately, many new investors seem to be under a misconception that it is a type of mutual fund. A Systematic Investment Plan is not a type of mutual fund; it is a method of investing in a mutual fund.
Here's to coming to terms associated with mutual funds. There are two ways in which we can invest in a mutual fund.
Ø A one-time outright payment
If we invest directly in the fund, we just hand over the cheque and we get our fund units depending on the value of the units on that particular day.
Let's say we want to invest Rs 10,000. All we have to do is approach the fund and buy units worth Rs 10,000. There will be two factors determining how many units we get.
a) Entry load
This is the fee we pay on the amount we invest. Let's say the entry load is 2%. Two percent on Rs 10,000 would Rs 200. Now, we have just Rs 9,800 to invest.
The Net Asset Value is the price of a unit of a fund. Let's say that the NAV on the day we invest is Rs 30.
So we will get 326.67 units (Rs 9800 / 30).
Ø Periodic investments or SIP (Our present area of concentration)
This is referred to as a SIP.
That means that, every month, we commit to investing, say, Rs 1,000 in our fund. At the end of a year, we would have invested Rs 12,000 in our fund.
Let's say the NAV on the day we invest in the first month is Rs 20; we will get 50 units.
The next month, the NAV is Rs 25. We will get 40 units.
The following month, the NAV is Rs 18. We will get 55.56 units.
So, after three months, we would have 145.56 units. On an average, we would have paid around Rs 21 per unit. This is because, when the NAV is high, we get fewer units per Rs 1,000. When the NAV falls, we get more units per Rs 1,000.
Other important points relating to SIP-
§ Exit load - An exit load is a fee we pay at the time of selling the units, just like the entry load is a fee we pay when we buy the units.
Initially, funds never charged an entry load on SIPs. Now, however, a number of them do. We will also have the check if there is an exit load. Generally, though, there is none. Also, if there is an entry load, an exit load will not be charged. An exit load may be charged if we stop the SIP mid-way. Let's say we have a one-year SIP but discontinue after five months, then an exit load will be levied. These conditions will wary between mutual funds.
§ Periodic Investments - If we do a onetime investment, the minimum amount that we have to invest is Rs 5,000.
If we invest via an SIP, the amount drops. Each fund has their own minimum amount. Some may keep it at least Rs 500 per month; others may keep it as Rs 1,000.
§ Frequency of investment - It would depend on the fund. Some insist the SIP must be done every month. Others give us the option of investing once in three months or once in six months. They also give fixed dates. So we will get the option of various dates and we will have to choose one. Let's say we are presented with these dates: 1, 10, 20 or 30. We can pick any one date. If we pick the 10th of the month, then on that day, the amount we have decided to invest in the fund has to be credited to our mutual fund.
§ Nature of payment - We can opt for the Electronic Clearance Service from our bank; this means the mutual fund will, as per our instructions, debit a certain amount from our account every month. Let’s say we have a SIP of Rs 1,000 every month and we have chosen to invest in it on the 10th of every month. Under this option, we can instruct our mutual fund to directly debit our bank account of Rs 1,000 on the due date. If we don't have the required money in our account, then for that month, no units will be allocated to us. But, if this continues periodically, the mutual fund will discontinue the SIP. We need to check with each mutual fund what their parameters are.
Alternately, we can give cheques to our mutual fund. In this case, they may ask for five Post Dated Cheques upfront with our first investment. Since these cheques are dated ahead of time, they cannot be processed till the date indicated.
§ Duration of investment – one have to state whether we want it for a year or two years, etc. If, during the course of this period, we realize we cannot continue with the SIP, all we have to do is inform the fund 15 days prior to the payout. The SIP will be discontinued. We can continue to keep our money with the fund and withdraw it when we want.
§ Type of funds that offer SIP - All types of equity funds (funds that invest in the shares of companies), debt funds (funds that invest in fixed-return investments) and balanced funds (funds that invest in both) offer a SIP.
Liquid funds, cash funds and floating rate debt funds do not offer an SIP. These are funds that invest in very short-term fixed-return investments. Floating rate debt funds invest in fixed return investments where the interest rate moves in tandem with interest rates in the economy (just like a floating rate home loan).
§ Tax implications - Let's say we have invested in the SIP option of a diversified equity fund. If we sell the units after a year of buying, there is no need to pay capital gains tax. If we sell if before a year, we are required to pay capital gains tax of 15%.
Let's say we have invested through a SIP for 12 months: January to December 2009. Now, in February 2010, we want to sell some units. The system of first-in, first-out applies here. So, the amount we invest in January 2009 and the units we bought with that money will be regarded as the units we sell in February 2010.
For tax purposes, the units that we sell first will be considered as the first units bought.
· How can be SIP is different and help full when compared to regular method of investing in mutual fund- When we buy the units of a fund, we may do so when the NAV is really high. For instance, let's say we bought the units of a fund when the bull Run was at its peak, leading to a high NAV.
If the market dips after that, the value of our investments falls and we may have to wait for a long while to make a return on our investment. But, if we invest via a SIP, we do not commit the error of buying units when the market is at its peak. Since we are buying small amounts continuously, our investment will average out over a period of time. We will end up buying some units at a high cost and some units a lower price. Over time, our chances of making a profit are much higher when compared to an one-time investment.