Name a long-term financial goal, and experts would chorus: you should start a Systematic Investment Plan (SIP) in an equity mutual fund. In fact, it is difficult to escape this ubiquitous strategy these days. Have you ever wondered what is so special about SIPs?
Everyone would talk about maximising profits as the main reason for recommending SIP strategy. But we believe that most important feature of SIP-based investing is imparting financial discipline in the lives of investors.
Many investors are on a start and stop mode of investing. They start investing when there is optimistic mood all around them. And they stop their investment when there is pessimism (read the market has tanked) around them. SIP puts an end to this dubious practice.
It forces investors to invest a fixed sum of money regularly irrespective of the market conditions. Since the money is directly debited from your bank account, the chances of you missing your investment or market conditions influencing your decision come down.
You can also set up the SIP date right after your salary date to ensure that you do not spend money before investing. It is almost impossible to create a large corpus unless you invest a small amount regularly over a long period.
For example, you simply can’t create a retirement corpus of Rs 1 crore on the eve of your retirement. Creating such a large corpus would definitely require you to set aside a fixed amount every month over a long period.SIP helps you to do it easily.
Benefit from the power of compounding
Compounding is about earning interest by reinvesting the interest earned. The magic of compounding can turn a small amount invested regularly into a very large corpus. Investment experts say that it is always better to start investing early with a small amount than waiting for a large sum to start investments.
Suppose you start investing Rs 1,000 every month in an equity scheme to meet a goal that is 10 years away. If your investment generates 12 per cent returns, you would get Rs 2,32,339 at the end of 10 years.
Now, imagine that you start investing Rs 1,500 five years before the goal to make up for the lost time. You would have only get Rs 1,23,729 at the end of five years.
Averaging your purchase cost
Stock market is known for its volatility. Investors usually try to circumvent the problem by timing the market: purchasing when the market is down and selling during the peak. But timing is not an easy thing to practice.
You can never be sure whether the market has hit the bottom or it won’t fall further. Or, the price won’t rise further. The only way to handle such uncertainty is to average out your purchase cost
The table below would help you to understand how investing through SIP averages out your cost price. For the illustration we have assumed that the NAV price has fluctuated between Rs 97 and 105. The amount invested every month is Rs 2,000. The average cost price is usually low over a long period.