If you have concluded that SIP is the safe and will always give your very good returns then you are mistaken. Firstly you need to know if Systematic Investment Plan (SIP) is right for you and then what is the right way of doing SIP. And since it concerns your money, you had better do what is right and not what is convenient.
What is SIP and how does it work?
SIP is a systematic way of investing in mutual funds just like Recurring Deposit is a way of systematically putting some of your savings into a FD, say every month. The primary reason one does RD is because one has generated some saving every month and an RD ensures it earns higher interest rate than a saving account’s i.e. you have put it to work a little harder.
Now it should be obvious to you that SIP in Mutual funds is an extension of the same logic. But mutual funds come with risks and the prices fluctuate, which can scare away simple investors. So there was a need to reassure investors that SIP actually made investing in mutual funds safer. And they called the reason why it makes it safer; dollar or rupee-cost-averaging, a fancy word for what is obvious. Here’s what it means. The markets keeps going up and down and hence when you invest the same amount every time you end up getting either a little less or a little more for the amount you invested. And like normal person you will divide your total investment in the MF by the total number of units you got and arrive at your average cost per unit.
So what’s the big deal, what the benefit of doing SIP?
The biggest benefit is that it liberates your mind of having to take a decision every time you have some money to invest. And one of your decisions may be to not invest and that certainly hurts the industry and it may also hurt you. Why, because you generate a surplus every month and need to put it to work harder for you, harder than an RD/FD if you have to beat inflation hands down. This is an important benefit, no doubt. Equity as measured by the popular Index (which means you invested in all the companies in the Index) is likely to give you the highest returns across all asset classes. Plus you have the benefit of buying and selling this very easily i.e. high liquidity. But putting money in an Index fund does not earn much money for the MF industry and to be fair the past track record seems to suggest that actively managed MF at least some/many of them will earn you higher returns than a passive Index Fund, despite their higher cost. So SIP ensures you put money regularly in the equity asset class through a diversified fund.
Now if you are a little confused, it’s alright. Better be confused, than be a lamb to the slaughter. Simply put SIP in Mutual Funds is a better way of investing your monthly surplus than RD/FD, provided you do it right. But don’t extend this to any of your lumpsum savings or investments e.g. don’t redeem your FD and start an SIP. And what if your monthly saving is large, say more than 40,000? Well its best to think of this as lumpsum money that you need to invest wisely and with the help of a zero-conflict advisor, as SIP is not the best solution for you.
Thus, SIP works when you have less than 40,000 monthly saving but you need to do it right to benefit from it. There are 4 things you need to get right. We call it the Power of 4. Read our next blog to know more on the Power of 4 and the right way to do SIP!
There is a lot written on SIP. You can read two well written articles to understand when it works and when it does not and why.
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