Understanding Mutual Fund SIP from the Scratch

guide to sip investment in mutual funds loanbaba

It is a common saying that one should save regularly, no matter how small the quantum is. Even small savings on regular basis result in huge corpus over a period of time. SIP (Systematic Investment Plan) is one such way of savings and investing regularly. Through SIP, an investor invests a fixed amount periodically in mutual fund for prefixed tenure which is chosen at the time of investment.

The periodicity of investment depends upon the nature of mutual fund, however most of the mutual fund companies offer SIP on monthly basis. Units of mutual fund to be allocated on the date of your investment are determined by NAV (net asset value) prevailing at that time. Higher the NAV, fewer units are allocated, and vice versa.

Read More: Types of Mutual Funds to Invest In

How Does SIP Work?

Suppose you have Rs. 120,000 and you intend to invest the amount in a mutual fund. Now, let’s assume that Sensex (market index of BSE) at that time is 20000. There are 2 cases depending upon the pattern of investment:

  1. Mutual Fund: You invest the whole amount in equity mutual fund with a NAV of Rs. 60 on 1st Hence you have 2,000 units of the mutual fund in your hand.
  2. SIP: Instead of investing whole amount in a single go, you opt for investing in the form of SIP in the same equity mutual fund. Assume that you invest Rs. 10,000 every month for next 12 months. NAV is supposed to be fluctuating over a period of 12 months as the markets are highly volatile. The investment will be in the following way:
Date Amount invested  (Rs.) NAV Units allocated
January 1 10,000 60 166.66
February 1 10,000 60.4 165.56
March 1 10,000 60.2 166.12
April 1 10,000 60.8 164.48
May 1 10,000 60.5 165.28
June 1 10,000 60.1 166.38
July 1 10,000 59.5 168.06
August 1 10,000 59.0 169.50
September 1 10,000 58.4 171.24
October 1 10,000 58.6 170.64
November 1 10,000 59.2 168.92
December 1 10,000 59.0 169.50
Total 120,000   2012.34

 

Now, with this option you own 2012.34 units of the fund in 12 installments at an average cost (NAV) of 59.63 per unit.

Amount invested in both the cases is the same i.e. Rs. 120,000 but in case of SIP, the units held are more than in case of mutual fund. This is due to the fluctuation in NAV of the fund because of volatility in markets. The NAV got lower in lowered than 60 in case of SIP and hence more units of fund got allotted.

Now, the question arises that if this particular scenario exists in all cases? No, not necessarily. All depends upon the market conditions and time when you are investing.

Read More: Points to Consider Before Investing in Debt Funds

Benefits of Systematic Investment Plan

  1. Disciplined investment: With the help of SIP, your financial discipline is maintained as you save and invest on regular basis. The SIP is a sort of forced commitment which helps you cut down the unnecessary expenses for the month and maintains the regularity of investment.
  2. No need of large lump-sum investments: With the help of SIP you can go for investment in small amounts. The amount of SIP can be as low as Rs. 500 on monthly basis. There is no need of taking a huge burden of investment at a time as it gives you an option of investing regularly in fixed small amount.
  3. Rupee cost averaging: You get more units unit of the fund when NAV is low and lesser units with a higher NAV; due to this the cost per unit goes lesser than the simple average NAV of that period. This is rupee cost averaging which proves to be beneficial to the investors.
  4. No need to time the markets: The retail investor in general is a layman and hardly knows about the market moves and is unknown of benefits of such movements. Lack of time to monitor is another constraint with the retail investor. In such a scenario, SIP helps the retail investors in averaging costs and also reduces market risk involved in investment.

Read More: How to Meet Your Financial Goals by Investing in Mutual Funds?

Drawbacks of Systematic Investment Plan

  1. Unsuitable in bull market: Bull market refers to a phase in the security market when there is a general hike in share prices as a consequence of good market conditions. At this point of time investing in SIP may let you get a fewer units than in case of mutual funds as the average cost gets higher. In bull market the NAV tend to increase.
  2. Lock in period in ELSS funds: The ELSS funds feature a lock-in period of 3 years from the date of investment in such fund. In case of SIP, each installment is locked in for 3 years individually from the respective date of investment and not from the date of entering the fund.

When Should You Choose SIP Investment?

SIPs can be purchased anytime except for the times when the market is anticipated to be bullish in near future, as the bull market results in increasing the NAV and you get returns lower than lump-sum investments. Hence an anticipated bear run in the market can be taken as the perfect time for investment in SIP.

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Understanding Mutual Fund SIP from the Scratch
Article Name
Understanding Mutual Fund SIP from the Scratch
Description
What is Systematic Investment Plan' (SIP)? How to make SIP investment in mutual funds? What is the investment pattern in SIP? How much return can I expect?
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Loanbaba
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