What is a Systematic Investment Plan?
If I invest today and the markets go down tomorrow what should you do?
How to invest so that one has not fear timing the market?
Investors face these questions while deciding the right time to invest in Mutual Funds, especially Equity Mutual Funds.
One of the easy, popular, and important tools to avoid the risk and trouble of timing the market is through SIP.
A systematic investment plan (SIP) is used to describe a periodic investment of certain amount over a predefined duration towards an investment option.
One simple example to understand SIP is that of Recurring deposits of banks.
Banks usually provide two kinds of deposit instruments the first being a Fixed deposit wherein an investor can deposit any amount for a duration of 7 days to 120 months and get a fixed interest on the same.
The second option that an investor can chose is that of recurring deposit wherein he can choose to deposit a certain amount over a period of months to years on a regular basis. E.g. a deposit of 5000 per month on the 25th of every month for 60 months.
Similarly, an investor can participate in an equity market that is more volatile and risky than investing in a fixed deposit.
In this case, either an investor can invest a lump sum (like a fixed deposit) for a stipulated time period and do a top-up as and when there are funds.
Else he can do a small regular investment for the stipulated time period hence investing every periodic time period and mitigating the risk.
There are various benefits of doing investment through the SIP route –
1. Inculcates discipline
For most people investing is not the top priority especially during the early stages of their earning.
Only when they spend a certain time and realize that they have to catch up a lot in terms of their long-term goals.
Such investors often make decisions in haste and go for wrong products or are prone to misselling and investing in wrong products that do not suit their needs.
SIP as an investment option creates a sense of discipline as it’s a regular (usually monthly) investment.
Many times investors schedule the SIP to such dates as it’s just a day or two later than their salary credit date so as to debit the account as soon as salary is credited so that they are left with the money for their expenses after investing and it becomes a sort of forced saving for them.
2. Timing of the market
Owing to the volatility of the equity market, investors are often skeptical of entering the market at the wrong time.
What if my portfolio goes down immediately after I invest?
what if I lose an opportunity of buying during a correction?
Many other such questions are there which bothers investors and makes them jittery toward investment.
To all such investors, SIP serves as a tool to average out the buying price and hence reduces the risk of any decrease in the NAV.
Hence eliminates the need of bothering about timing the market.
An illustration in the same regard is shown in the table below –
The table shows the SIP amount of 5,000 done per month for 10 months and two comparisons have been made, less volatile (Blue color) and Highly volatile (pink color) with various NAV (Net Asset Value ) at the time of investment.
We can draw the following inferences from the above table –
- Less Volatile – clearly shows that from the period of Jan 2018 to Oct 2018 the markets were slightly volatile (reflected by a change in the price per unit) hence the investor has a risk of buying at a higher price if he enters with the entire investment corpus at a single go.
But if he does a systematic investment plan spread over a period of 10 months his average cost of acquisition/buying the NAV’s i.e. the average price that he pays instead of all the volatility over the period of 10 months is only 99.58.
- Highly Volatile – in this scenario, we can observe that there is very high volatility over a 10 month period where the NAV fluctuates from a high of 113 (buying at this price can be a costly affair) to a low of 73 (buying at this point could be a smart move).
As an investor, it is very hard to predict when the markets will bottom out hence in such a situation a SIP will result in an average buying price of 92.71.
3. Building a large corpus by small contribution –
For example, if one has to buy a house worth 2 crores not many would be able to pay the entire amount at one go.
Instead, we would look to take a home loan where we can pay some amount monthly (EMI) in installments over a period of time which varies from a few years to as high as 20-30 years.
Through this approach, we are getting the ownership of a house without having paid a huge amount.
Similarly, not every investor has a huge investment corpus to invest at one go (lump sum), and even when one has so, investing the entire amount at one time poses a risk to the investor.
If the market goes down the investor has a risk of negative return or an opportunity loss of getting a better price point.
SIP helps such investors to build a huge corpus by investing small amounts at regular intervals.
The above table clearly shows that even for a Conservative Investor (return of 8%) and for a short-term time horizon (5 years) a contribution of 10,000 per month will amount to 7.34 lakh.
Whereas for a long-term aggressive investor with an average return of 16% with a time horizon of 20 years a monthly contribution of 10,000 will result in a total corpus of 1.72 crores.
If we take an average return of 10% (moderate) over different time periods the returns would look as depicted in the table below –
In the long term, one can easily observe that total interest earned is more than twice of the amount invested.
Hence amounting to a considerable total amount at maturity (75.93 lakh) which comes from the fact over long-term compounding also plays a huge role.
Two important hacks for SIP-
Do a SIP in the last week of the month
It has been observed historically that the stock market ( BSE and NSE) tend to correct during the last week of the month since last Thursday of the month is when future and options contract expire hence the markets remain volatile and it’s prudent to do the purchase of SIP during that period so as to get the cheapest buying point.
Step-up SIP with time
One mistake that an investor does (especially those who are in their late 20’s or early 30’s) is to continue with the same amount of SIP for the duration that they have decided.
But as one’s income increases they should allot an increased proportion to the SIP portfolio as well.
For example, an investor can opt for the “Step up SIP” option and select the percentage that he wants to increase every year (say 10%) and it automatically increases the allotment from the next year.
Similarly, an investor can opt for perpetual SIP which means that the SIP will continue to exist until it is manually stopped which makes sense for a long-term investor and he is saved from the hassle of forgetting the SIP re-allotment once the duration is finished.
For example, if an investor opts for a 5 year(60 months) SIP he might forget to re-start the same after maturity but in the case of a perpetual SIP it continues until he stops.