It's a common saying that little drops of water make a mighty ocean. This wisdom can extend to our investments as well. It is not always necessary to invest large sums of money to accumulate a corpus as it puts unwarranted pressure on finances. Even small amounts invested regularly over longer periods can help in wealth creation. It is this feature which makes mutual funds a convenient and attractive investment option.
Just as banks offer regular investment facility, called recurring deposit (RD), mutual funds offer an investment facility called systematic investment plan (SIP).
The investor has to select the fund for SIP investment. Next, he/she has to specify the investment amount, identify the interval, the tenure and the date of investments. This is a one-time process and the selected mutual fund will debit the amount directly from one's bank account.
The benefits offered by SIPs are as follows:
Low investment amount: Depending on how much you earn and are able to save, you can arrive at an amount to invest. MFs allow the flexibility to invest as low as Rs 500 a month so that you don't have to stretch your finances.
Flexibility to select SIP dates: It is not necessary to do an SIP on the first day of the month. MFs allow options of multiple dates throughout the month, like 1st,7th, 10th, 14th, 15th, 21st, 25th and 28th, for your debits. You can split and spread your SIP amount across the month by selecting multiple dates for various funds. It is also possible to invest at monthly or quarterly intervals.
Disciplined approach: We often ponder on the right levels to invest in the equity market, but seldom get it right. SIPs eliminate such futile attempts of timing the market. It is a very useful tool, especially in volatile markets, which takes the guesswork out of investing. SIPs help maintain a disciplined approach to investing.
Rupee cost averaging: When the markets are high, your SIP buys lesser number of units compared to the number of units when the markets are low. SIPs, thus, reduce the average cost of buying mutual fund units providing the benefit of rupee cost averaging. When the markets are falling, the rupee cost averaging can reduce the loss compared to a lump-sum investment. In a rising market, however, lump-sum investments would do better. However, SIPs work best in a volatile scenario over the long term.
There have been many misconceptions about SIPs and their use. Let's try to debunk a few of these myths.
Myth: SIP is another type of equity fund
Let us get the basics right. SIP is not any kind of scheme. It is a facility which helps you to invest in schemes offered by mutual funds in a convenient and investment friendly manner. Therefore, one does not invest "in" SIPs, one invests in various schemes "through" SIPs.
Myth: SIP eliminates the need to select a fund
The performance of your SIP depends on the performance of the underlying scheme in which you invest. So, if an underlying scheme outperforms its benchmark, so will your SIP band and vice-versa. Therefore, it is imperative that before choosing a fund to start an SIP, you need to keep in mind your risk profile, look at the current and previous performance of the fund and pedigree of the fund house. Although past performances does not guarantee future performances, this homework gives us comfort while we invest.
Myth: SIPs are only meant for small investors
Small investment amounts are a convenience provided by SIPs for those who wish to invest but do not have a high disposable income. SIPs are also possible with high amounts. An SIP of Rs 10,000 or Rs 1,00,000 will yield the same returns and bear the same expense ratios. Only the absolute accumulated amount will differ because of the SIP amount.
Myth: You cannot lose money investing through SIP
SIPs do not guarantee returns. You may even incur losses. For you to make money, the average selling price has to be greater than the average cost price. The underlying premise about the success of SIPs in equity mutual funds is that the equity markets will do well over the long term.
Suppose you invest through an SIP and were able to purchase units at an average unit price of Rs 110. For you to make money, the unit price has to be above Rs 110 at the time of sale. If it is less than that, you incur a loss. SIPs, however, help in reducing the average purchase cost of the mutual fund units.
Myth: SIP returns on an absolute basis are low
Like lump-sum investments, it is not right to look at SIP returns on an absolute basis. It is like comparing apples and oranges. SIP investments are made at different intervals. Hence, the internal rate of return (IRR) is the right way to compute SIP returns. Mutual fund scheme fact sheets provide these returns for your reference.
Myth: You cannot stop an SIP or withdraw before the tenure
This is another common misunderstanding about SIPs. Most investors somehow have a notion that SIPs offer low liquidity and they cannot stop the investments once committed for long periods. This is not true.
If at any point in time you feel that you cannot continue investing because of some financial contingency, you can always terminate your SIP any time before the completion of the tenure. The money you have invested so far can remain invested in the fund. Similarly, if need be, withdrawals can be made through the accumulated corpus any time. However, these withdrawals may be subject to exit loads, which would marginally eat into your corpus.
SIP is a good facility to access the equity market as they offer several benefits and provide the flexibility to invest according to your requirement. You can also add to your overall corpus by stepping up the SIP amount each year to match your growing income. This helps in reaching your financial goals faster. So. go ahead and "SIP" your way to wealth creation.
The writer is managing director of Kotak Mahindra Asset Management Co Ltd
