Investing SIP by SIP

MONEY & YOU

In the middle eighties, maintaining recurring deposits at banks were all the rage. Of course, in those days interest rates were as high as 15 per cent per annum and even small instalments of a few hundred rupees could result in substantial savings over time.

Recurring deposits are still there but given the prevailing low interest rates, investors are not too keen on investing in them.

But those who would like to put in small amounts of money somewhere "" probably every month, every two months, every quarter and so on depending on savings ability "" can take a look at systematic investment plans (SIPs) offered by mutual funds.

SIPs are actually a disciplined way of investing as it forces you to set aside a specified amount every month (assuming you are doing it monthly). This money is also not lying idle but will be earning something as the mutual fund will be investing it for you.

It is helpful especially for those who do not have a huge sum to invest in one go, but can invest in small amounts. But the most important factor with an SIP is that you do not have to time the market.

For instance, when investing in a mutual fund scheme, if the net asset value of that scheme is high, it is natural to feel some hesitation about entering at such a high price.

In an SIP, since you are investing in small amounts over a longer period, timing becomes irrelevant. You get more units when the market is down and lesser units when the market is up for the same money. So over a period of time, your cost of acquisition automatically averages out.

Let us take an example. We will assume a market that is volatile. Suppose you invest Rs 1,000 every month. In the first month, if the NAV of the scheme is Rs 10, you would get 100 units for your money. Then in the second month assume that the market has gone down and the NAV is Rs 8.20. You would get 122 units (rounded off).

In the third month the NAV has gone down further to Rs 5.40 and you would get 185 units. In the fourth month, the price rebounded and the NAV is now Rs 9.60. You'll have 104 units credited to your account. In the fifth month the market is really booming and the NAV is now Rs 11 per unit and the fund credits you with 91 units.

So total investment made is Rs 5,000 over five months and you have 602 units to show for it. So the average cost is Rs 5,000/602 or Rs 8.31 per unit.

The average purchase price is Rs 8.84 per unit. The average unit cost (of acquisition) is lower than the average unit price.

Now let us assume a scenario where the market is rising. Again, the first month you bought 100 units for Rs 1,000 at Rs 10 per unit. In the second month, the NAV rises to Rs 10.50 and you get 95 units.

In the third month the price has gone up further to Rs 11.50 and you get 87 units. In the fourth month the fund credits you with 83 units at Rs 12 per unit. In the fifth month, the price has gone up to Rs 12.50 and you get an additional 80 units.

Thus for Rs 5,000 invested across five months, you get 445 units. So your average cost is Rs 5,000/445 or Rs 11.24 per unit. And the average purchase price is Rs 11.30 per unit.

So in both cases you see that your average unit cost is lower than the average unit price. As the period lengthens "" that is, if you invest over a longer period of time "" the benefits are greater as the discrepancy widens to your advantage. It could be worth checking out.

HOW TO SIP: All mutual funds offer SIPs in their schemes. As an investor you have to specify the instalment amount that you can pay, the frequency at which you can pay, and the number of years that you intend to pay.

Based on this, the mutual fund will activate your SIP. Since fund houses generally have tie-ups with banks, you can even mandate the fund to debit your account for the specified amount so that you are saved the hassle of depositing cheques.