Monday, March 26, 2007

Systematic Investment Plan (SIP)

Systematic Investment Plan (SIP) – the time-tested method to multiply your money!

The Indian stock market is synonymous with volatility and dynamism. What is the strategy for investors like you and me to sail smoothly in a storm? Past experiences have shown that a disciplined investment plan holds the key to ride bulls and bears in the market. One of the most convenient methods of investing in the stock markets is the SIP. SIP is a powerful tool, with a strategy of not only preserving capital but also translating into substantial creation of wealth in the long run.

What is a Systematic Investment Plan ?

SIP is a method of investing a fixed sum, regularly, in a mutual fund. A SIP allows you to buy units on a pre-determined date at pre-determined intervals at the prevailing NAV on that day. Once you have decided the mutual fund scheme in which you want to invest and on the amount you want to invest and the frequency of investment (monthly or quarterly), you can either give post-dated cheques or ECS instruction, and the investment will be made regularly. SIPs generally start at minimum amounts of Rs 500 per month and the upper limit for using an ECS is Rs 25000 per instruction. Therefore, if you wish to invest Rs 1,00,000 per month, you may need to do it on 4 different dates.Think of each SIP payment as laying a brick. One by one, you will see them transform into a building. You will see your investments grow steadily month after month. Being disciplined is, no doubt, the key to successful investing.

Exploding the myths on SIP

The seemingly simple SIP has been one of the most misunderstood concepts associated with mutual fund investment. Let us now break some myths associated with SIP.

Investment in equity mutual funds should always be done in SIP mode: If you have the maturity and serenity to realize that equities are for the long term and are willing to leave your funds untouched for about 10 years and you have a substantial sum, you can afford to give the SIP route a slip. However, if your horizon is less than five years, SIP is the best alternative.

Rupee cost averaging in a single equity is a kind of SIP : Rupee cost averaging in a single scrip cannot be equated to a SIP. When the market brings down the price of a single scrip, it is giving you information. You need to react to that. Silverline Technologies moved from Rs 30 to Rs 1300 and then to Rs 7! In this case, if you had started a SIP at a price of Rs 1300, today you would be licking your wounds. SIP works in a portfolio (hence a mutual fund) and not in a single scrip.

You cannot invest a lump sum in the same account in which you are doing a SIP: Many people assume that if they are doing a SIP in a particular fund and they have an unexpected surplus, they cannot put that amount in that account.The fact is, in case you are doing a SIP of Rs 10,000 per month in an equity fund and suddenly you have a surplus of Rs 100,000 and you have a 10-year view on the same, then you can just add it to your SIP account. SIP is just a payment mode, not a scheme!

Fear of procecution in the event of non-payment of a monthly investment: In a SIP (unlike an EMI), you are buying an investment every month (or quarter). There is no question of prosecuting you for missing one investment. As a matter of discipline, you should not miss any payment.

SIP works for everybody, but does not work for me: A psychological myth. SIP works in a well-diversified equity fund in the long run. When people put forth arguments that it does not work for them, they have either not chosen a good fund or are looking at a 12 month horizon.

Now that the common misconceptions about SIP have been clarified, I shall discuss some unique advantages that elevate this mode of payment to the pedestal that it deserves in the subsequent blog.

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