A Systematic Investment Plan (SIP) is a vehicle offered by mutual funds to help you save regularly.
It is just like a recurring deposit with the post office or bank where you put in a small amount every month. The difference here is that the amount is invested in a mutual fund.
The minimum amount to be invested can be as small as Rs 100 and the frequency of investment is usually monthly or quarterly.
How an SIP works
An SIP allows you to take part in the stock market without trying to second-guess its movements.
An SIP means you commit yourself to investing a fixed amount every month. Let's say it is Rs 1,000.
When the NAV is high, you will get fewer units. When it drops, you will get more units. { NAV : Net Asset Value , or the price of one unit of a fund. Can be computed as follows : NAV = [ market value of all the investments in the fund + current assets + deposits - liabilities ] divided by the number of units outstanding.}
| Date | NAV | Approx number of units you will get at Rs. 1000 |
|---|---|---|
| Jan 1 | 10 | 100 |
| Feb 1 | 10.5 | 95.23 |
| Mar 1 | 11 | 90.90 |
| Apr 1 | 9.5 | 105.26 |
| May 1 | 9 | 111.11 |
| Jun 1 | 11.5 | 86.95 |
Within six months, you would have 5,89.45 units by investing just Rs 1,000 every month.
Over the long run, you make money
Let's say you invested in Prudential ICICI Technology Fund during the dotcom and tech boom.
Say you began with Rs 1,000 and kept investing Rs 1,000 every month. This would be the result:
Investment period
- Mar 2000 ๏ฟฝ Mar 2005
Monthly investment
- Rs 1,000
Total amount invested
- Rs 61,000
Value of investment of Mar 7, 2005
- Rs 1,09,315
Return on investment
- 23.87%
Had you bought the units on March 13, 2000 at Rs 10.88 per unit (that was the NAV then), you would have lost because the NAV was just 7.04 on March 7, 2005. But because you spaced out your investment, you won.
How an SIP scores
It makes you disciplined in your savings. Every month you are forced to keep aside a fixed amount. This could either be debited directly from your account or you could give the mutual fund post-dated cheques.
As you see above, it helps you make money over the long term. Since you get more units when the NAV drops and fewer when it rises, the cost averages out over time. So you tide over all the ups and downs of the market without any drastic losses.
Also, a number of mutual funds do not charge an entry load if you opt for an SIP. This fee is a percentage of the amount you are investing. And if you do not exit (sell your units) within a year of buying the units, you do not have to pay an exit load (same as an entry load, except this is charged when you sell your units).
If, however, you do sell your units within a year, you would be charged an exit load. So it pays to stay invested for the long-run.
The best way to enter a mutual fund is via an SIP. But to get the benefit of an SIP, think of at least a three-year time frame when you won't touch your money.
Of course you would lose money if your units lost value over time
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