Arun, working with a media company in Mumbai, is worried over his savings. He is about to get married to his longtime girl friend. The only saving Arun has is a small FD, but considering high inflation, it may not be sufficient to take care of the future needs of the couple. Since Arun could not afford a lumpsum investment in any investment vehicles, a financial planner advised him to invest in mutual funds using a Systematic Investment Plan (SIP). Investing a fixed amount of money each moth suited Arun as he did not have to worry about creating a corpus to start investing. Many investors today use the systematic investment plan to enter the financial markets and taking the advantage of compounding returns in the best way. Let us look at various aspects of systematic investment and its apparent benefits.
Understanding Systematic Investment Plans:
Systematic investment plan as the name suggest allows a user to build an investment portfolio with a small systematic investment at regular intervals. The investor can choose his or her preferred mode of investment as monthly, quarterly or annually and invest the funds according to his or her convenience. Users of systematic investment plans can choose from various investment vehicles to invest their money including stocks, mutual funds, ETFs and even gold funds.
Advantages of investing using a systematic investment approach:
Investment discipline: The one basic rules of investing is to always maintain a focused and dedicated approach towards investment. A large number of people enter the investment markets with a lot of enthusiasm but fail to maintain a monthly investment towards building a regular investment corpus. Investing in a systematic investment plan allows users to maintain a monthly investment scheme which is far easier to maintain in the long run rather than investing a lump sum amount each year. Investing in systematic investment plans must be considered by all investors who are yet to attain an investment discipline allowing them the convenience to invest a pre determined short sum every month towards their future.
Rupee cost averaging:
Rupee cost averaging, also commonly known as RCA is one of the very significant reasons why investing in a systematic investment plan must be considered by almost every investor. Investors investing a fixed amount of money every month towards any investment vehicle allow them to purchase more units or stocks when the price of the investment is lower. This reduces the average cost of purchasing of the financial asset over time. Considering a long term investment approach, rupee cost averaging can even out any market ups and downs in the long term, allowing the investor to gain maximum benefits ion his or her investments over time.
In simplistic terms, let us consider an investor is investing a monthly fixed amount in a mutual fund investment plan. Considering the fact that the investor invests the same amount each month irrespective of the market cycle, be it a bull phase or a bear phase, the average cost of investment is eventually maintained at a lower level allowing maximum gains in the long term.
Power of compounding:
One of the basic rules of being a successful investor is to start early. Since all investment and returns are based on the power of compounding, an investor starting out early can earn much higher returns than a one starting out late even with a slightly higher corpus. Since a systematic investment plan do not seek a large amount of investment and users can start investing with a low sum each month depending on their financial condition, it allows them to start investing much early in life.
Let us consider Mr. A and Mr. B and understand how the power of compounding helps the investor using a systematic approach. Mr. A started investing in a systematic investment plan investing a sum of Rs. 1000 when he was 30 years old. By the time Mr. A reaches 50 years of age, he would have invested Rs. 24 Lakhs if the money grew on an average rate of 7% per annum.
Now let us consider Mr. B who starts out earlier than Mr. A and started investing the same amount of Rs. 1000 from the time he was 20 years old or ten years earlier than Mr. A. Mr. B’s investment growing at the same rate of 7% per annum would end up as high as Rs. 36 Lakhs by the time he is 50 years old.
So while both Mr. A and Mr. B invested same amount each month, the one starting out early has made a substantial gain compared to the one starting out late.
Investment convenience:
A systematic investment plan as the name suggests is systematic in nature allowing the investor the advantage of investing small amount of money each month without any hassles. The investor can send a onetime instruction to his or her bank to allow auto debit of the investment amount each month from his or her savings bank account allowing systematic investments without worrying about missing out on any monthly investment.
Other benefits:
A systematic investment plan offers a number of miscellaneous benefits that make investment quite comfortable and an enjoyable experience. One can start investing in a systematic investment plan with a very low amount of Rs. 500 or Rs. 1000 per month. This allows users of all financial backgrounds to invest in capital markets without feeling the pinch of a lump sum investment. A large number of fund houses waive off entry or exit load on mutual funds in case the investment is done through a systematic investment plan. SIPs also offer a taxation benefit as SIPs are taxed for capital gains on first in first out basis.