What is a Systematic Investment Plan?
A Systematic Investment Plan or SIP is a smart and hassle free mode for investing money in mutual funds. SIP allows you to invest a certain pre-determined amount at a regular interval (weekly, monthly, quarterly, etc.). A SIP is a planned approach towards investments and helps you inculcate the habit of saving and building wealth for the future.
How does it work?
A SIP is a flexible and easy investment plan. Your money is auto-debited from your bank account and invested into a specific mutual fund scheme.You are allocated certain number of units based on the ongoing market rate (called NAV or net asset value) for the day.
Every time you invest money, additional units of the scheme are purchased at the market rate and added to your account. Hence, units are bought at different rates and investors benefit from Rupee-Cost Averaging and the Power of Compounding.
With volatile markets, most investors remain skeptical about the best time to invest and try to time their entry into the market. Rupee-cost averaging allows you to opt out of the guessing game. Since you are a regular investor, your money fetches more units when the price is low and lesser when the price is high. During volatile period, it may allow you to achieve a lower average cost per unit.
Power of Compounding
Albert Einstein once said, "Compound interest is the eighth wonder of the world. He who understands it, earns it... he who does not... pays it." The rule for compounding is simple - the sooner you start investing, the more time your money has to grow.
If you started investing Rs. 10000 a month on your 40th birthday, in 20 years time you would have put aside Rs. 24 lakhs. If that investment grew by an average of 7% a year, it would be worth Rs. 52.4 lakhs when you reach 60.
However, if you started investing 10 years earlier, your Rs. 10000 each month would add up to Rs. 36 lakh over 30 years. Assuming the same average annual growth of 7%, you would have Rs. 1.22 Cr on your 60th birthday - more than double the amount you would have received if you had started ten years later!
Other Benefits of Systematic Investment Plans
Disciplined Saving - Discipline is the key to successful investments. When you invest through SIP, you commit yourself to save regularly. Every investment is a step towards attaining your financial objectives.
Flexibility - While it is advisable to continue SIP investments with a long-term perspective, there is no compulsion. Investors can discontinue the plan at any time. One can also increase/ decrease the amount being invested.
Long-Term Gains - Due to rupee-cost averaging and the power of compounding SIPs have the potential to deliver attractive returns over a long investment horizon.
Convenience - SIP is a hassle-free mode of investment. You can issue a standing instruction to your bank to facilitate auto-debits from your bank account.
SIPs have proved to be an ideal mode of investment for retail investors who do not have the resources to pursue active investments.
What is Systematic Transfer Plan? How does it work?
Investors can use Systematic Transfer Plan (STP) as a defence mechanism in volatile market. This plan is used to transfer investment from one asset or asset type into another asset or asset type. Read this space to know all about STP and how does it work?
STP is a variant of SIP. STP is essentially transferring investment from one asset or asset type into another asset or asset type. The transfer happens gradually over a period. STP and its importance Systematic Transfer Plan is of two types; fixed STP, and capital appreciation STP. A fixed STP is where investors take out a fixed sum from one investment to another. A capital appreciation STP is where investors take the profit part out of one investment and invest in the other. Example of STP Suppose you have invested 5 lakhs in debt funds because you thought market is trading at close to peak.
The PE ratio of the market is 25 and hence you think that fall is imminent. Hence you invested your money in debt fund. Now assume that your prophecy was right and the market indeed fell to a level where you can make entry to equities. However, there are overall weak sentiments which may push market further down. What is the best strategy in this case? You can take out 5 lakhs out of debt fund and invest in equity oriented mutual fund. The risk is that if the market goes further down, your fund value will also fall. This is a risky strategy. Moreover, if the weak sentiments prolong for some time, you will lose on the opportunity cost because your money is stuck with an investment which has gone down in value. There is other way which can really minimize the risk.
The way is called STP. In this case, you can withdraw a fixed amount from your debt fund investment and invest in equity oriented fund. This can go on for several months depending upon your choice. For example, if you want to continue STP for 3 years, you can direct your fund to do this and the fund will withdraw money automatically from your debt fund and put into equity oriented fund every month. What this strategy achieves is that it essentially acts as a defence against any adverse movement of the market.
Important points to keep in mind STP is a possibly the second best investment strategy after SIP. It is one of the best risk mitigation strategies of the market. Investors though should keep the following points in mind. First, STP is a risk mitigation strategy. It will protect you from any adverse loss to a large extent. Investors should be clear about this. All risk mitigation strategies cap the loss but also reduce returns when market is bullish. Second, investors need to follow it with discipline. STP, just like SIP, benefits only when followed properly. Breaking STP because of short term market movement or interest rate movement will only harm your investment in long term. Finally, you need to understand the assets and the stages they are in.