The nuts and bolts of how a mutual-fund systematic-investment plan, or SIP, works in your favour
Pondering what an SIP is? Over the last 15 years, everyone who is serious about investing and enhancing their wealth may have encountered the word SIP, one place or another. Worry not. SIP is not some fancy mumbo-jumbo or a sophisticated gizmo, but the initials of a “Systematic Investment Plan”.
It’s actually mutual funds that are instrumental in introducing the word SIP into our lexicon of investment terms.
THE BASICS OF SIP
If we roll back a little, let’s look at the term ‘recurring deposit.’ This is a deposit where you make period and regular investments in a bank or a deposit account. A recurring deposit can be done either monthly or quarterly, which is why it is called a ‘recurring deposit.’
Akin to this, a systematic investment plan is a scheme where you make regular and periodic investments into a mutual fund scheme of your choice. This investment is done either monthly or quarterly. The popular choice with a lot many investors, though, is the monthly option.
In a monthly plan, investors automatically direct their bank accounts to invest a monthly sum in a ‘specific’ fund. The bank transfers the money to the fund you selected, and buys mutual fund units in lieu of the investment amount you made. These units are your investment holdings in the fund.
For every month that you make an investment into the fund, you are credited with mutual fund units in your account.
Hence, the more investments you make, the more mutual fund units you will accumulate.
WHY SIPS ARE A COMFORT
The good thing about starting a SIP account is that it helps even out the ups and downs due to market fluctuations. Equity markets, as we all know, swing either up or down. But a regular SIP can get around this swinging market by accumulating more units of a mutual fund when the market dips or bagging less units when the markets rise.
So, it not only accumulates more and more units at regular intervals in your account, but it averages the price at which you have snagged these units.
For example, if the mutual fund unit value, better-known as net asset value is valued at Rs 100 when you say purchased Rs 10,000 worth of units, you will receive 100 units of the fund in your account. The next month, when the unit value is Rs 105, for a sum of Rs 10,000 you will receive 95.3 units in your account. Again in your next SIP installment, if the unit value is 95, your account will get credited by 105.3 units in your account.
Over time, your unit acquisition price will remain steady, irrespective of market fluctuations. It’s almost impossible to accurately predict how stocks move. But a SIP with its automatic investment feature, will eliminate this uncertainty and marshal up a sizeable amount of units in your SIP account. And before you know it, you would have accumulated a tidy fortune.
