SIPs: All you need to know

Regular visitors and clients appreciate the importance of the systematic investment plan (SIP) route of investing in mutual funds. However it is surprising to note that it takes difficult times (read volatile markets) for the investing community at large, to appreciate the importance of such a handy facility.

Simply put, investing via an SIP entails making regular investments (generally) in smaller denominations as opposed to making an one-time lump sum investment. The intention is to capitalise on the volatility in equity markets by lowering the average purchase cost. While few would dispute the utility that an SIP can offer, there is a flipside to the same as well. In this article, we discuss the pros and cons of SIP investing.

How an SIP helps. . .

1. Lowers the average purchase cost

Perhaps the single most important advantage offered by an SIP is the opportunity to lower the average purchase cost. This is achieved in periods when equity markets experience a turbulent patch.

Since the investment amount for each installment is fixed, the investor gains by receiving a higher number of units. An example will clarify this better. Suppose the monthly investment installment is Rs 1,000 and the fund's net asset value (NAV) is Rs 50; this will lead to 20 units of the fund being credited to the investor.

However, in the next month on account of the volatile markets, the fund's NAV falls to Rs 40. This will lead to a lowering in the average purchase cost; as a result, the investor will have 25 units credited to his account. In other words, an SIP can help investors benefit from volatility in equity markets.

2. Induces disciplined investing

Lack of disciplined investing is one of the major reasons for investors not achieving their financial goals. For example, often monies that are kept aside for investment purpose end up getting used for extraneous purposes.

As a result, the investor is even further divorced from his goals. An SIP ensures that the investor continues to be invested in a disciplined manner and thereby stays on course to achieve his financial goals.

3. Lighter on the wallet

An often heard excuse for not investing is lack of monies. SIP takes care of this problem by lowering the minimum investment amount.

For example, while the minimum investment amount for a lump sum investment in a diversified equity fund could typically be Rs 5,000, for an SIP it can be as low as Rs 500. As a result, investing via the SIP route becomes lighter on the wallet.

4. Makes market timing irrelevant

Along with cricket and movies, timing the market ranks as a popular pastime. Investors have an inexplicable urge for timing markets and trying to get invested when markets have bottomed out. It's a different matter that timing markets to perfection and doing so consistently is beyond most investors.

An investment via the SIP route makes market timing irrelevant. On account of the on-going investments, investors can afford to bid adieu to one of their favourite pastimes and concentrate on more pressing matters.

When an SIP won't deliver�

1. In rising markets

An SIP could fail to deliver on its proposition of lowering the average purchase cost, if equity markets rise in a secular manner. Such a scenario is fairly possible over shorter time periods. As a result, investing via an SIP could prove to be more expensive vis-�-vis a lump sum investment. Hence, the solution lies in opting for an SIP that runs over an appropriate time frame, say at least 12-24 months.

2. A directionless SIP

By a directionless SIP, we are referring to an SIP that is not a part of an investment plan or an aimless SIP. It should be understood that an SIP is not an 'end'; instead, it is the 'means' to achieve an end. Hence starting an SIP in isolation is unlikely to be of too much help. Instead, the SIP should form part of an investment plan aimed at achieving a predetermined objective.

3. An SIP in the wrong fund

Investing via the SIP mode doesn't improve the prospects of a wrong fund. A poorly managed fund stays that irrespective of the investment mode. Its shortcomings will not be eliminated by an SIP. Hence the key lies in first selecting a well-managed fund that is right for the investor and then investing in it via an SIP.

As can be seen, the SIP mode of investing has a fair number of advantages to offer; conversely, there can be instances when it may not deliver as expected. Investors on their part should make well-informed investment decisions after acquainting themselves of both the pros and cons.