Benefits of SIPs

Systematic Investment Plan allow investors to invest using small periodically amounts.

Investing is smart, but investing wisely is smarter. Most of us would like to create wealth quickly, but making money quickly comes with risks and a higher probability of losing money than earning it. Besides, one needs to be very well informed about how, where, when and how much to invest, failing which, you can give up the idea of making a quick buck.

Did you know that some of the biggest and most successful billionaires, including Warren Buffet – the guru of Wall Street, who made big time money on the stock exchanges, actually created wealth over the long term and by investing consistently and regularly on the same stocks over the years. They now sit on stocks that they bought at very low cost and over a period kept adding more shares of the same stocks that today define them as billionaires.

Warren Buffet bought his first stock at the age of 11 and he hasn’t stopped buying till date. But buying stocks needs deep research and thorough evaluation to determine which stocks will give the best return over the long term, and if you don’t have the time, inclination or knowledge, then one of the best options to explore is investing in a Systematic Investment Plan (SIP).

Understanding SIPs

SIPs are most suited for the small investor who can afford to set aside small amounts, as little as Rs 500 every month, over a long period. Most of us are busy in our daily lives and don’t have the time, inclination or knowledge to invest in shares. The mistake we make is that we wait for a lumpsum money to come to us by way of an annual company bonus, or a gift from a friend or relative, and expect to put that money into some form of investment, if at all.

What we don’t realize is the power of money compounding and the advantage of rupee cost averaging.

It’s just a movie!

First, let’s take a look at what we lose if we don’t understand the value and power of money. Say you go to watch a movie at a multiplex every month with a friend. It would be a fair estimate to imagine around Rs 1,000 spent on tickets and eatables. Just one movie every month, that’s 12 in a year – not really an excessive splurge. And, let’s say you did this for 10 years. At the end of 10 years, you would have spent Rs 12,000 per year x 10 years = Rs 120,000! This is money gone out of your pocket without you feeling the pinch. After all, it’s just one movie!

During the same period, another friend of yours decides to invest Rs 1,000 in an SIP every month for 10 years. At the end of 10 years, his investment would be worth Rs 6,69,000 @ 9%!

Both of you had an outflow of Rs 1,000 every month for 10 years, but while you LOST Rs 1.2 lakh, your friend actually ‘created wealth’ worth Rs 6.69 lakh! If he were to continue investing for a longer period, his wealth creation would be even more substantial, while you would still be watching movies every month!

No, he didn’t need any special knowledge about shares or companies, nor did he need time trying to figure out which shares to buy or sell, just plain simple setting aside of Rs 1,000 every month. Now imagine, if you could set aside Rs 3,000 or Rs 5,000 every month! That’s the secret to long term wealth creation, slowly but steadily.

SIPs enable us to invest in small amounts as per our capabilities, without any limitation of entry or exit. We can invest for a minimum period of just six months or longer, and choose either a monthly or quarterly plan, although a monthly option is always a better one, as it keeps the amount small and regular, without pinching our budget. After all, one movie a month doesn’t really hurt, or does it?

Power of Rupee cost averaging

Since shares are regularly purchased every month by the fund manager on your behalf, the advantage is that you acquire more shares when the prices are low and fewer shares when the market price is high, since the budget is fixed for each month. Over the long term, the rupee cost of averaging negates any market volatility that happens and your wealth continues to grow slowly and steadily.

Short term share trading vs SIPs

Many of us believe investing in shares is risky business, since we keep hearing of markets going through a bull or bear phase, almost all the time.

When we buy or sell shares over the short or even medium term, we expose ourselves to market fluctuations, and this can be very uncertain and risky. Besides, one has to have a larger amount available to purchase some of the better shares. The way to avoid this problem is to invest in an SIP which purchases some of the best shares available and which have the highest probability of giving the maximum returns over the long term. SIPs are relatively safe and enable you to enter the equity markets with small amounts.

SIPs vs Recurring Deposit (RD)

Both require a fixed amount to be deposited on a monthly basis. While in the case of RD, the bank invests the amount in government debt funds and the interest is compounded monthly. The rate of interest varies as per the tenure but usually is around 8% annually.

In SIPs, the investor’s deposit is invested in equity markets and therefore offer a higher return that could average around 15% annually, if the period is longer than 5-8 years.

While the total amount earned in RD is predictable, the amount could vary in the case of SIPs and is subject to market conditions. The advantage of SIP is that when the tenure is over 5 years, the volatility of bull and bear conditions of stock markets average out. Historically, the better SIPs have offered an average return of 15%, with some exceeding 25%.

Which SIPs should I invest in?

SIPs are offered by many Mutual Fund houses and several leading banks. Performance of each can vary, but returns over the long term tend to be better than any other investment option like FDs, Saving plans, Recurring Deposits etc. One must research the past performance of various SIPs before investing, but one must also keep in mind that past performance is no guarantee of future returns.

 

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