Monday, April 02, 2007

Systematic Investment Plan (SIP) ..(contd.)

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

The proof of the pudding lies in the unique advantages that SIP enjoys…

No strain on your day-to-day finances

Mutual funds were never meant to be elitist; far from it. The retail investor is as much a part of the mutual fund target audience as the high networth investor (HNI). Investing smaller amounts over a period of time is a lot more convenient, particularly for the salaried class. Given that average per capita income of an Indian is approximately Rs 25,000 (i.e. monthly income of Rs 2,083), a Rs 5,000 one-time entry in a mutual fund is still asking for a lot (2.4 times the monthly income!). So, if you cannot shell out Rs 5,000, that is not a huge stumbling block. Take the SIP route and trigger your mutual fund investment with as low as Rs 500 (in most cases).

Relevance of market timing reduced

Studies have repeatedly highlighted the ability of stocks to outperform other asset classes over the long-term (at least 5 years) as also to effectively counter inflation. So, if stocks are such a great thing, why are so many investors complaining? It is because they either got the stock wrong or the timing wrong. Both these problems can be solved through a SIP in a mutual fund with a steady track record. One of the biggest difficulties in equity investing is WHEN to invest, apart from the other big question of WHERE to invest. While, investing in a good mutual fund solves the issue of ‘where’ to invest, SIP helps us to overcome the problem of ‘when’.

With a SIP, you are relatively indifferent to how stock markets behave over a period of time. The truth is, none of us can time the market. No one knows when a fund's NAV will rise or fall. When the market is falling you may feel that it may decline further and that you should wait a while. Often stock markets make a recovery before you notice and the opportunity is lost. When markets are rising it is scary to invest money. Isn't it better that you wait for a correction and then make an investment? But if the correction doesn't come about, then even this opportunity is missed. And if markets are going nowhere, then what is the point in investing at all? It thus makes the market timing totally irrelevant.

Reduces the average cost

In a SIP, you invest a fixed amount regularly. Therefore, you end up buying more number of units when the markets are down and NAV is low and less number of units when the markets are up and the NAV is high. This is called rupee-cost averaging. Generally, you would stay away from buying when the markets are down. and tend to invest when the markets are rising. SIP works as a good discipline as it forces us to buy even when the markets are low, which actually is the best time to buy.

The magic of compounding unfolds

The early bird gets the worm is not just a part of the jungle folklore. Even the early investor gets a lion’s share of the investment booty vis-à-vis the investor who comes in later. The following example illustrates how the power of compounding can do wonders. Imagine A is 20 years old when she starts working. Every month she saves and invests Rs. 5,000 till she is 25 years old. The total investment made by her over 5 years is Rs. 3 lakhs. B also starts working when he is 20 years old. But he doesn’t invest monthly. He gets a large bonus of Rs. 3 lakhs at 25 and decides to invest the entire amount. Both of them decide not to withdraw these investments till they turn 50. At 50, A’s investments have grown to Rs. 46,68,273 whereas B’s investments have grown to Rs. 36,17,084.A’s small contributions to a SIP and her decision to start investing earlier than B have made her wealthier by overRs. 10 lakhs. Benjamin Franklin had once said “ Compound interest is the eighth wonder of the world”. And no doubt it is. Even if each investment is small, over time this can add up to a neat kitty.

Helps realize our dreams

Most of you have needs that involve significant amounts of money, like child’s education, daughter’s marriage, buying a house or a car. If you had to save for these milestones overnight or even a couple of years in advance, you are unlikely to meet your objective since many of them require a huge one-time investment. As it would usually not be possible to raise such large amounts at short notice, you need to build the corpus over a longer period of time, through small but regular investments. This is what SIP is all about. Small investments, over a period of time, result in large wealth and help fulfill your dreams & aspirations.

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