What is SIP? Why it’s the best way of investing?

February 4, 2018 0 Ankit Shrivastav

Introduction:

The poor and middle class work for money, the rich make money work for them. -Robert Kiyosaki

The above quote sums up the secret of money and wealth in a precise way. The secret of getting rich is not just to work for money, but to make money work for you. Investing your money and creating a passive source of income ensures that you don’t have to work throughout your life in order to survive. While this sounds very interesting, most investors find it difficult to choose the right product or strategy that makes them money consistently while making sure they don’t have to keep tracking their investments on a daily basis.?SIP or Systematic Investment Plan is a great investment strategy that not only provides above average return on investments, but also relieves investors from tracking their investments on a daily basis.

What is SIP?

SIP is an investment strategy where investors invest small amount of money on a regular basis, the setup is such that a fixed amount is auto debited from investors bank account and is invested in a well diversified portfolio of stocks managed by fund manager, whose job is to maximize the return on investment while minimizing the risk. SIP is a very simple, self regulated method used for long term investing in stocks providing higher returns what is provided by fixed income instruments.

How does SIP Work?

SIP is very much similar to recurring deposit of bank where a small amount of money is invested every month and grows at a fixed interest rate. In an SIP plan, investors choose a fund that is in sync with his long term investment goals, and invests a fixed amount of money every month. This small amount of money grows at a compounding rate, higher than average growth provided by fixed income instruments. Over the long term, these small amounts invested regularly become a big corpus, sufficient to meet the financial goal of the investor.

There are many advantages of investing using SIP, some of the biggest advantages of investing via SIP are mentioned below:

Advantage SIP investing

You can start with a small amount:

The biggest advantage of starting an SIP is that you do not need huge sum of money to begin. An investor can start one with a small sum as small as Rs. 500 per month. It is a great investment option for young investors that have just started to earn and cannot save lot of money every month. Even if your savings are not very large, you can still take advantage of the economic growth story of India and get higher returns compared to the ones offered by fixed income instruments.

You do not have to worry about market timing:

While investing in stocks, the biggest challenge a retail investor faces is market timing. Market timing means finding the right time or levels of the market where possibility of upside movement is maximum. While market timing has its own advantages, it is art that is difficult to master even for professional investors. The advantage of investing in SIP is that you do not have to worry about timing the market. SIP is a self regulated method which automatically buys more stocks when they are cheaper and less when they are expensive. Let us understand this with the help of an example.

Let us say you are investing in a stock that is currently trading at Rs. 100 per share. If you invest Rs. 1,000 every month, you will be able to buy 100 shares of the company each month. Let us now assume, because of a market correction the price of the stock comes down to Rs. 50 per share. If you still continue to invest the same amount, because of the price correction, you will be able to buy 200 shares for the same amount of money. By continuing to buy stocks even at lower prices, you take advantage of something called cost averaging, which means that you bring down the average cost of investment significantly by adding more shares to current holding at lower price.

Your money grows with a compounding effect:

In the long term, the price of the stock is largely determined by the performance of the business. If a business does well and makes lot of profits, which increases the networth of the company, the price of the stock appreciates accordingly. The secret to buying a good stock lies in buying a good business. When you buy a good stock and stay invested in it for long term, you get the advantage of compounding in two different ways.

First, as the business grows and appreciates in value, the price of the stock appreciates accordingly. Just like in a fixed income instrument, whatever interest you earn is added back to your principal and you get a higher amount every year compared to what you get previously.

Second, since the company re invests a part of its profit every year to its business, the business earns higher profit every year while its capital base remains the same. This is similar to buying a bind with an expansive coupon (expansive coupon means a bond that pays higher rate of interest every year compared to previous year)

You keep emotions at bay:

In the short term, market move considerably. This may cause greed or panic among investors as seeing such ups and downs you might feel like making an impulsive purchase or sale. This is usually not a good idea as most of these fluctuations are temporary and are just collective sentiments of short term investors which do not reflect the actual underlying fundamentals of the company. By investing via an SIP plan, you prevent yourself from reacting impulsively, and remain disciplined focusing on the long term goals rather than short term volatility.

You can start, stop, skip or even modify your SIP investments:

SIP provides lot of flexibility in terms of how when and how much you want to invest in an SIP plan. You can start a SIP whenever you want, without waiting for a specific time or date. You can also increase or decrease the monthly amount of investment you want to make in case you start to earn more and save more every month. If you are unable to save enough money at the end of a specific month, do not worry, SIP allows you to skip an installment in case you are unable to save money.

We have already understood the SIP and its advantages in detail, however, there are some important points you must keep in mind before and while investing in an SIP. There are many mistakes that people make while investing in an SIP, by avoiding them, you can take the maximum advantage of the amazing money making method world has ever seen. What are those mistakes and how to avoid them? Here are the details:

Avoid these mistakes while investing in an SIP:

Investing for a very short term:

SIP is a long term investment plan, where small amounts invested regularly for a long time becomes a sizable corpus over a period. Investing in SIP funds with a short term investment horizon will not be very beneficial as investor wont get the advantage of compounding growth. ?Longer your time horizon, better will be the returns.

Picking the wrong schemes:

Most investors choose a fund looking at its past performance while some other pick a sector specific fund just because it is performing well for quite a long time. Both these bases of choosing a fund are wrong and may not help you fulfill your financial goals. An investor should chose a fund that are in sync with ones financial goals. For Example, If your purpose of investment is to earn a higher return on investment while minimizing risk, balanced funds might be suitable option for you. If your purpose of investment is to earn higher return on investment while getting some tax benefit, ELSS (Equity Linked Saving Scheme) might be a good option for you as they invest 80% of your money in equities and provide tax benefits under Section 80C.

Starting with too small amount:

Agreed, that SIP allows you to start with as small amount as Rs. 500 per month, but keep that in mind, the more you invest the bigger will be your corpus, and faster you will reach closer to your financial goals. An investor must raise his monthly amount. Once you reach a comfortable position of earnings, you should raise your monthly investment to align your investment with your financial goals.

Conclusion:

SIP is one of the most innovative, self regulated and flexible investment method for small retail investors. It does not require large investment amount to begin, buys more when the stocks are trading at attractive valuation and remains invested for long term taking advantage of compounding returns. With little discipline and patience, you can ensure achieving financial goals and living a secure financially prosperous life.