Importance of SIP (Systematic Investment Plan) in mutual funds is best understood when stock indices are fluctuating frequently. SIP, simply means investing money at regular intervals in smaller quantity as opposed to making an one-time lump sum investment.

The intention is to capitalise on the volatility in equity markets by lowering the average purchase cost. While few would dispute the utility that an SIP can offer, there is a flipside to the same as well. In this article, we discuss the pros and cons of SIP investing.

How SIP helps
*Lowers the average purchase cost: Perhaps the single most important advantage offered by an SIP is the opportunity to lower the average purchase cost. This is achieved in periods when equity markets experience a turbulent patch. Since the investment amount for each installment is fixed, the investor gains by receiving a higher number of units. An example will clarify this better.

   Suppose the monthly investment installment is Rs 1,000 and the fund’s net asset value (NAV) is Rs 50; this will lead to 20 units of the fund being credited to the investor. However, in the next month on account of the volatile markets, the fund’s NAV falls to Rs 40.

    This will lead to a lowering in the average purchase cost; as a result, the investor will have 25 units credited to his account. In other words, an SIP can help investors benefit from volatility in equity markets.

nInduces disciplined investing: Lack of disciplined investing puts us in trouble. Often money kept aside for investment purpose end up getting used for extraneous purposes. As a result, the investor is even further divorced from his goals. An SIP ensures that the investor continues to be invested in a disciplined manner and thereby stays on course to achieve his financial goals.

*Lighter on the wallet: An often heard excuse for not investing is lack of monies. SIP takes care of this problem by lowering the minimum investment amount.

   For example, while the minimum investment amount for a lump sum investment in a diversified equity fund could typically be Rs 5,000, for an SIP it can be as low as Rs 500. As a result, investing via the SIP route becomes lighter on the wallet.

*Makes market timing irrelevant: Investors often try to time the market without luck and try to get invested when markets have bottomed out. Timing markets to perfection and doing so consistently is beyond most investors. An investment via the SIP route makes market timing irrelevant. On account of the on-going investments, investors can afford to bid adieu to one of their favourite pastimes and concentrate on more pressing matters.

When SIP won’t deliver
*In rising markets: An SIP could fail to deliver on its proposition of lowering the average purchase cost, if equity markets rise in a secular manner.

Such a scenario is fairly possible over shorter time periods.

    As a result, investing via an SIP could prove to be more expensive vis-a-vis a lump sum investment. Hence, the solution lies in opting for an SIP that runs over an appropriate time frame, say at least 12-24 months.

*A directionless SIP: An SIP that is not a part of an investment plan is an aimless SIP. It should be understood that an SIP is not an ‘end’; instead, it is the ‘means’ to achieve an end. SIP should form part of an investment plan aimed at achieving a predetermined objective.

*An SIP in the wrong fund: A poorly managed fund stays that irrespective of SIP. Its shortcomings will not be eliminated by an SIP. Hence the key lies in first selecting a well-managed fund that is right for the investor and then investing in it via an SIP.

   As can be seen, the SIP mode of investing has a fair number of advantages to offer; conversely, there can be instances when it may not deliver as expected.

   Investors on their part should make well-informed investment decisions after acquainting themselves of both the pros and cons.

Source: Personalfn, a financial planning initiative. For information email: info@personalfn.com