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Investing in systematic investment plans negates the need to time markets

Investors looking to put money into mutual funds have two main options — a lump sum investment or a systematic investment plan (SIP). When one invests a lump sum in a mutual fund, it is tantamount to timing the market, and results in increasing one’s risk. On the other hand, when investing through the SIP route, an investor does not need to time the market and can benefit from both falling and rising market scenarios. Lump sum investing is useful if investing in a safe debt instrument, but for equity investments timing the market is crucial — and this is notoriously difficult. The SIP route is safer and more rewarding in the long run for equity instruments.

SIP plans were introduced in 1997, in an effort to improve saving habits of people. One can now invest regularly in a mutual fund at various intervals ranging from daily to fortnightly to monthly to quarterly, with each installment being as low as Rs 500. These plans work best for investors with long investment horizons, for example a newly married couple saving for their child’s education and marriage.

Investment through the SIP route inculcates financial discipline as a regular investment is done automatically. Disciplined investing is a key when building wealth and one of the easiest ways to stay disciplined is to invest through SIPs. It is easier to invest a few thousand rupees each month rather than set aside money to make a lump sum investment at a later date.

SIPs also help to create wealth by providing the benefits of averaging, which means in a rising market the investor will get more returns, while in a falling market one will get more units for one’s investment; over a period of time the returns are higher. This does away with the need to time the market — a difficult proposition even for seasoned investors.

Let us explain this with an illustration — assume there are two investors, investor A who invests Rs 12,000 over six months in an SIP (at Rs 2,000/month), and investor B who invests Rs 12,000 in one lump sum. Both investors start their investments on the same date. As seen in the table on the right, investor A ends up with 1,118 units at the end of six months, while investor B has 1,091 units for the same period. Assuming the NAV is Rs 13 at the date of redemption, Investor A makes a return of 21 per cent compared with investor B’s return of 18 per cent.

In the event that an investor has a large sum of money to be invested, and doesn’t want to wait to invest it all through the SIP route, there is the option of a systematic transfer plan (STP). In this route, one can invest the money into a liquid scheme of a fund house, and on a given schedule transfer funds from this into an equity scheme from the same fund house.

Another advantage of a SIP is that is it easy on your monthly budget. If one wants to save Rs 2 lakh a year, it will be a burden on the income stream to save this at one go. However, if this is split into manageable chunks, it makes it is easier to save.

It is advisable to remain invested through SIPs for as long as possible, as investors can then benefit from the power of compounding. An investor putting in Rs 1,000 per month through a SIP will have over Rs 18 lakh in 30 years (assuming a return of 9 per cent per annum) thanks to the power of rupee cost averaging and compounding.

It is best when identifying funds, to check their track record, and it is advisable to look at the three-year, five-year and since inception returns, as this will show how the fund performed in various market conditions. Also, when investing in a SIP, it is better to decide on how much one can invest each month before deciding on the funds — for smaller amounts, it is better to maintain a smaller portfolio, as regular portfolio monitoring is required.

Taxation on SIP investments are done on a first-in, first-out basis, meaning if the initial investment is redeemed after a period of one year, there is no capital gains tax.

As seen, investing through the SIP route is more beneficial than a lump sum investment. However, the only situation wherein a lump sum would give better returns will be in a cyclical bull market — as with an SIP one would be buying lower number of units at higher prices. It is advisable to check with a financial adviser before investing in either option.

Matter of facts:

n Smaller investment sizes leads to disciplined investments

n SIPs work on the principal of rupee cost averaging — benefiting the investor in both rising and falling markets

n One can use the STP route to invest single sums of money through an SIP into equity mutual funds.

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