Systematic Investment Plan Overview

A Systematic Investment Plan, also known as an SIP, is an investment strategy offered by mutual funds to investors. An SIP allows an investor to invest small amounts of money regularly rather than investing a single large amount.

The relationship between a Systematic Investment Plan to a one time Mutual Fund Investment is the same as that between a recurring deposit and a fixed deposit.

The frequency of the investments is usually monthly although some people also opt for weekly or quarterly investments.

When is Systematic Investment Plan useful?

Most people have a very unstructured approach to investing and wealth creation. There are two reasons for this.

1. Year End tax savings based investments – In India most salaried people, invest during the Financial Year end, so that they may avail tax benefits. That is a completely incorrect approach.

Investment should be goal based, regular and disciplined. After evaluating various investment options, one should along with his financial planner, choose the most suitable investment avenue with respect to wealth building and tax savings.

2. Gold, Fixed Deposits and LIC Fixation – Indians are fixated with gold, Fixed Deposits and LIC plans. Without much thought they will put money in these products with no regards to goals and benefits.

That is why, although many people earn a lot, they are not able to build wealth.

A disciplined approach to investing helps in wealth creation. Regular investing helps in wealth creation.

Systematic Investment Plan offers both – a regular and disciplined approach to investing.

Illustration of Systematic Investment Plan

I will illustrate Systematic Investment Plan using 2 scenarios – increasing NAV and decreasing NAV.

Mr Rudrendra plans to invest Rs 60,000 in a mutual fund. At this point however, he does not have the full amount. He analyzes his income and expenses, and concludes that he may be able to invest Rs 5,000 every month.

Mr Rudrendra decides to go for a 12 months Systematic Investment Plan of Rs 5,000 per month.

Let us see what happens to his monthly investments.

Case 1 – Increasing NAV

Systematic Investment Plan - Increasing NAV

Month 1 – The NAV is Rs 60. Mr Rudrenda receives 83.33 units (5000/ 60).
Month 2 – The NAV increases to Rs 66. Mr Rudrenda receives 75.76 units (5000/ 66) which is lower than last month.
Month 3 – The NAV again decreases to Rs 60. Mr Rudrenda receives 83.33 units, which is higher than Month 2.
And so on.

At the end of 12 months, his status is as below.
Total Investment – Rs 60,000
Total Units – 935.43
Average buying price – Rs 64.14
Current NAV – Rs 71.00
Value of Investment – RS 66,416 (Rs 71 X 935.43 )

If however, Mr Rudrendra had invested lumpsum amount of Rs 60,000 in month 1, things would have been different.

Total Investment – Rs 60,000
Total Units – 1,000
Buying Price – Rs 60.00
Current NAV – Rs 71.00
Value of Investment – RS 71,000 (Rs 71 X 1,000.00 )

In this case, a slightly reduced return is the price Mr Rudrendra has to pay for the convenience of monthly investment.

Case 2 – Decreasing NAV

Systematic Investment Plan - Decreasing NAV
Month 1 – The NAV is Rs 71. Mr Rudrenda receives 70.42 units (5000/ 71).
Month 2 – The NAV decreases to Rs 70. Mr Rudrenda receives 71.43 units (5000/ 70) which is higher than last month.
Month 3 – The NAV again decreases to Rs 68. Mr Rudrenda receives 73.53 units, which is higher than Month 2.
And so on.

At the end of 12 months, his status is as below.
Total Investment – Rs 60,000
Total Units – 935.43
Average buying price – Rs 64.14
Current NAV – Rs 60.00
Value of Investment – RS 56,126 (Rs 60 X 935.43 )

He has made a loss on his investment.

If however, Mr Rudrendra had invested lump-sum amount of Rs 60,000 in month 1, things would have been different.
Total Investment – Rs 60,000
Total Units – 845.07
Buying Price – Rs 71.00
Current NAV – Rs 60.00
Value of Investment – RS 50,704 (Rs 60 X 845.07 )

His loss would have been much higher.

In this case, Systematic Investment Plan helps Mr Rudrendra to reduce his losses from RS 10,000 to Rs 4,000.

Conclusion

A Systematic Investment Plan is a flexible and convenient investment option.

  • Systematic Investment Plan allows an investor to invest in a disciplined manner.
  • An SIP helps an investor to invest regularly.
  • Systematic Investment Plan is very convenient for those who cannot afford to invest lump-sum.
  • An SIP helps to reduce losses in a downward market because of rupee cost averaging.

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A Few Last Words

Before making any investment decision, please contact your financial adviser. I have provided this article for educational purpose only.

I hope you found this article on Systematic Investment Plan useful. If you have something to add please leave a comment in the post. Please feel free to contact me.

Subhodeep Mukhopadhyay

I am a Management Consultant in the Education Sector. In my previous corporate career, I have worked in Banking, Private Equity and Software industry. I am an MBA in Finance/ Computer Engineer and enjoy doing equity research and financial analysis in my free time.

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