Systematic Investment Plans in Mutual Funds

Ashish Goel | September 17,2014 03:09 pm IST

The Case Of Chinese Bamboo:-
Let me narrate to you a story.

It's the story of Ganesh, the farmer, who used to live in a small village and used to earn very little.

Once upon a time a very renowned wise man visited his village. Ganesh thought to visit him and seek some advice from him about his meager income. The wise man advised him to cultivate Chinese Bamboo. He had never heard about it before, but he went on to cultivate it.

He planted a little seed, watered it and fertilized it for a whole year. But, nothing seemed to happen. The next year he again watered it and fertilized it, but to his dismay nothing happened again. The third year the same thing happened and he got very discouraged. He thought that he has been mislead by that wise man. But, he still watered it for the fifth year. This time to his amazement, the bamboo tree sprouted and grew NINETY FEETS in 6 weeks. This way the poor Ganesh became a rich man and all his woes came to an end.

A Systematic Investment Plan, or SIP, is a simple yet a powerful tool used by investors worldwide as a method for savings and wealth accumulation. It works on the principle of Chinese Bamboo. That is, you will reap unbelievable returns only in the longer run. Investing through SIP facility will empower you to plan and save for your future by inculcating in you a disciplined habit of investing that should bring you closer to achieving your financial objectives.

SIP Defined
Systematic Investment Plan or SIP is a disciplined way of investing one's money in order to take advantage of the volatility in the market, and thus drawing maximum benefit out of our investments over a longer period of time. In it an investor invests a pre-specified amount in a scheme at pre-specified intervals at the then prevailing NAV. By investing through this route the investor actually ends up with more number of units and hence can get more returns whenever he disposes them off. This happens due to the reduction in average cost of each unit of the scheme that is purchased.

Now lets look at how it works.

How Does SIP Works for the Investors?

Benefits to the investors:
1. Makes market timing irrelevant
2. Helps you build for the future
3. Compounds returns
4. Lowers the average cost
5. Light on the wallet
6. Saving for different Investment goals
7. Opportunity Cost saved by the Investor

Market Timing Irrelevant
Most investors want to buy stocks when the prices are low and sell them when prices are high. But timing the market is time-consuming and risky and involves lot of element of judgment. A more successful investment strategy is to adopt the method called Rupee Cost Averaging. To illustrate this lets compare investing the identical amounts through a SIP and in one lump sum.

SENSEX From Apr 04 - Mar 05


Concept of Rupee Cost Averaging
Imagine Karan invests Rs.1000 every month in an equity mutual fund scheme, starting in January. His friend, Arjun, invests Rs. 12000 in one lump sum in the same scheme. The following tables illustrate how their respective investments would have performed from Jan to Dec:

As seen in the table, by investing with a SIP, Karan ends up buying more units when the price is low and fewer units when the price is high. However, over a period of time these market fluctuations are generally averaged. And hence the average cost of the investment is often reduced.

At the end of the 12 months, Karan has more units than Arjun, even though they invested the same amount. That's because the average cost of Karan's units is much lower than that of Arjun. Arjun made only one investment and that too when the per-unit price was high. Karan's average unit price = 12000/1480.6012 = Rs. 8.105 Arjun's average unit price = Rs. 9.345.


The Power of Compounding
The only solution to effective saving is regular investment, i.e., saving consistently over a period of time. Hence, from the power of compounding we can expect our periodic investments to grow to a considerable amount.

The power of compounding is involves nothing but the concept of Future value of Annuities. An annuity is a series of equal payments or receipts that occur at evenly spaced intervals. Leases and rental payments are examples. The formula for calculating this future value is given by:

FV = PMT [{(1 + i)n - 1} / i]

FV = Future Value of an Annuity
PMT = Amount of each payment
i = Interest Rate Per Period
n = Number of Periods

Just to illustrate, consider investing Rs.5000 at the end of every year for the next 5 years. Let the compounded annualized return be 6%. Thus, we will accumulate Rs. 28,185.46 at the end of 5 years. The following calculations show the results.


From the above table we can see, that, when an amount of Rs. 5000 is deposited at the end of every year. In it the previous years interest is also added to the accrued amount till that period to get the interest of the next year, thus giving a compounded return.

Light On The Wallet
Depending upon your earning capacity we can invest through SIP route. That is, for low-end savers the minimum SIP amount is Rs. 1000. Hence, giving the investors an option to save at a much higher rate of return than the banks etc. and that too at a low SIP amount.

In the SIP route the AMC's do not charge any entry load, which again allows the whole investment of an investor to be used. However, there is a CDSC (Contingent Deferred Sales Charge) of X% on equity schemes redeemed in less than N years (This CDSC value depends upon the discretion of the AMC).

Saving for Different Investment Goals


Ashish is working as Channel Head - Private Banking at ICICI Prudential AMC Ltd. He completed MBA from IMT Nagpur and B.E. from Delhi College of Engineering. ...