This is a continuation, or rather an extension of our previous article, what are mutual funds? If you are well aware about what mutual funds are, how do they work, what are pros and cons of investing in mutual fund, Then you can go right ahead with this article, otherwise we would recommend reading the post about mutual funds, first clearing concept about mutual funds and then moving on here.
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What is SIP (Systematic Investment Plan)?
SIP stands for Systematic Investment Plan. What it actually is nothing but a fancy word for EMI in savings. That’s right, have you heard the phrase, “boond boond se ghada bharta hai”. That’s exactly what it means. Just like when you don’t have enough water to fill the entire vase, but every single drop is an addition to make it full. But the subtle thing here is discipline, a continuous process of saving rather than just one shot of saving.
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Why Consider Systematic Investment Plan?
SIP enforces you to make a habit of saving, and that’s a really good thing. We all have expenses, and we all get greedy sometimes. Oh! A sale is coming on Amazon, let’s buy that new smartphone, we’ll save next month. What? A new restaurant is opening, but short of funds, oh well! We can save money next month, so let’s try the restaurant first. What about that new Avengers movie that just launched? Or a trip to Kerala? So, for one reason or another, if we don’t make a habit, and more important, we don’t enforce that habit, then we skip the saving and our well will never get full.
With SIP, you can set up an automatic system, that once every month (or every week, or based on any frequency that you select), that particular amount will be auto debited from your account and invested into the mutual funds of your choice, and basis the nav, a certain number of units will be allocated to your account. So, once you set up the SIP, you don’t have to remember about saving, and it is automatically done on your behalf, forcing you into a habit of saving. Of course, you always have the option to manually pause or stop the SIP in case of some emergency, but you should not get into the habit of doing that as that would defeat the whole purpose of systematic saving.
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Systematic Investment Plan (SIP) vs One Time Investment
You always have the option to invest/save all your money at once but that may not be as efficient as the other option. They both have their own use, and you can’t replace one with another. One time investment is the best option when you have a bunch of money and you want to invest all that in savings. But that does not mean you should not start a SIP, because as we just explained, SIP enforces a habit of saving. As units allocated to your demat account are based on the nav, averaging out over a period of time is more. Let’s understand with an example.
- Principal -> Rs 10,000
- Current Price -> Rs 500
- Scenario one -> one time investment -> units allocated at once -> 20
- Scenario two -> invest Rs 1000 per month
- Month 1 ->
- Price -> 500
- Untis allocated -> 2
- Month 2 ->
- Price -> 550
- Units allocated -> 1.82
- Month 3 ->
- Price -> 487
- Units allocated -> 2.05
- Month 4 ->
- Price -> 440
- Units allocated -> 2.27
- Month 5 ->
- Price -> 387 ->
- Units allocated -> 2.58
- Month 6 ->
- Price -> 423
- Untis allocated -> 2.36
- Month 7 ->
- Price -> 498
- Units allocated -> 2.00
- Month 8 ->
- Price -> 530
- Units allocated -> 1.88
- Month 9 ->
- Price -> 512
- Units allocated -> 1.95
- Month 10 ->
- Price -> 490
- Units allocated -> 2.04
- Month 1 ->
- Total units allocated => 2+1.82+2.05+2.27+2.58+2.36+2+1.88+1.96+2.04 = 20.96
As you can see, with one time investment, we get the units based on the price at that point, but when we spread out the money over a period of time in SIP, then we might get more units (of course, we could also get less units, if the price only goes up in the subsequent times, but as we suggested in our article about mutual funds, the SIP and mutual funds are a long term investment, and in the long term the price goes up and corrects in a pattern.
In conclusion, SIP is one of the best ways to start saving for the long term. Check out our article on how to start a SIP in zerodha.
