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Systematic Investment Plan: A study - Views on News from Equitymaster
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  • Oct 1, 2001

    Systematic Investment Plan: A study

    What is Systematic investment plan (SIP)?
    SIP is an investment option that is presently available only with mutual funds. The other investment option comparable to SIPs is the recurring deposit schemes from Post office and banks. Basically, under an SIP option an investor commits making a regular (monthly) investment in a particular mutual fund/deposit.

    How to invest in SIPs?

    • The SIP option is available with all types of funds like equity, income or gilt.

    • An investor can avail the SIP option by giving post-dated cheques of Rs 500 or Rs 1,000 according to the funds’ policy.

    • If an investor wants to put more than Rs 500 or Rs 1,000 in any given month he will have to fill in a new a form for SIP intimating the fund that he is changing his SIP structure. Also he will be allowed to change the SIP structure only in the multiples of the SIP amount.

    • If an investor is investing in two different schemes of the same fund he can fill in a common SIP form for all the schemes. However if the first holders in those schemes are different than they will have to fill different SIP forms, as the first holder has to sign on the form.

    • The investor can get out of the fund i.e. redeem his units any time irrespective of whether he has completed his minimum investment in that scheme. In such a case his post-dated cheques will be returned back to him.

    Lets take an example:

    • An investor, ‘Rahul’ wants to invest in fund ‘X’ which can be an equity, income or gilt fund.

    • The policy of fund ‘X’ for entering in an SIP is that the investor will have to issue 6 post-dated cheques of Rs 500/- in case of monthly option or 4 cheques in a quarterly option. The minimum investment for all its schemes is Rs 5,000. ‘Rahul’ issues 6 post-dated cheques of Rs 500/- each in the name of fund ‘X’, with the first cheque being dated as on 7th May 2001.

    • Now in the month of August 2001 ‘Rahul’ wants to change his SIP structure from Rs 500/- to Rs 1,000/-. In this case he will have to intimate the fund and will have to fill a new SIP form issuing news post-dated cheques of Rs 1,000/- each.

    • ‘Rahul’ is investing in three different schemes of fund ‘X’. In two of the schemes ‘Rahul’ is the first holder and in the third scheme his wife is the first holder. In this case he can fill a common SIP form where he is the first holder and where his wife is the first holder he will have to fill in a new SIP form.

    • In the month of September 2001 ‘Rahul’ wants to exit from the fund. He will have to just give a redemption request to the fund wherein his units will be redeemed and his remaining post-dated cheques will be returned back to him irrespective of whether he has completed his minimum investment in the fund.

    Investing in SIPs is also known as Rupee cost averaging. The advantage of rupee cost averaging is that the Net asset value (NAV) is averaged out, as the investor will be entering the fund at different NAVs, which may be higher or lower depending on the market condition.

    Lets take the example of ‘Rahul’ wherein he has started investing in units every month since he issued the first cheque on 7th May 2001. In this example we assume that he does not change his SIP structure and also does not redeem the units.

    Investment in fund 'X' of Mr. Rahul
    Period Investment(Rs) NAV(Rs per unit) Units allocated
    7th May'01 500.0 10.0 50.0
    7th June,01 500.0 13.0 38.5
    7th July'01 500.0 10.5 47.6
    7th Aug'01 500.0 9.5 52.6
    7th Sep'01 500.0 8.0 62.5
    Total a=2,500   b=251.2

    Actual average NAV (Rs.) = Rs 10.2 per unit
    NAV for Rahul= Rs 9.95 per unit (a/b)

    The above table shows clearly how rupee cost averaging works and how it was beneficial to ‘Rahul’. The actual average NAV of a fund is Rs 10.2/- per unit, but the average NAV for ‘Rahul’ is Rs 9.95/- per unit, which is lower than the current NAV.

    An investor who is not having a lump-sum amount to invest and also does not want to take much risk on his investment should always select a ‘Systematic Investment Plan’ option. This will enable him to invest regularly i.e. improve investing discipline. Also, the investor stands to benefit from rupee cost averaging.

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