Understanding 'Systematic Investment Plan' (SIP)

Benjamin Graham, the father of value investing, has termed dollar cost averaging as one of the top 3 tenets of investments for a defensive investor. Dollar cost averaging is nothing but the systematic investment plan.

Systematic investment plan is a scheme which allows investors to invest in a mutual fund a certain amount of money over a period. For example, investors can invest Rs 5000 in a mutual fund every month.

Advantage of SIP

Systematic investment plan has many advantages over one time investment. Some of the advantages are mentioned below.

Price averaging: SIP allows you to average the price over long period so that theimpact of changing prices of mutual fund is minimized. You can buy more units when the prices drop and buy less when the prices move up. The advantage is that you do not have to worry about price movement.

Discipline: SIP instills in you a sense of discipline towards investment and savings.

Low base requirement: You can start SIP with a much lower investment. Many banks and financial institutions allow investment via SIP as low as Rs 500 a month.

Example:

Let's see how SIP works. The table below shows the monthly data of a mutual fund by Birla Sun Life. The fund is Birla Sun Life Small & Midcap Fund – GROWTH. The NAV is highest NAV for the month.

Top of Form Mar- 2010 Bottom of Form	11.46	5000	436	1784	20000	11.21	20448 Top of Form
Apr-2010	12.33	5000	406	2190	25000	11.42	26991
May-2010	12.07 Bottom of Form	5000	414	2604	30000	11.52	31437Bottom of Form
Jun - 2010Bottom of Form	12.15	5000	411	3015	35000	11.61	36639Top of Form
Jul-2010	12.78	5000	391	3406	40000	11.74	43542
Aug-2010	13.35 Bottom of Form	5000	374	3781	45000	11.90	50488Bottom of Form
Sep-2010	13.69	5000	365	4146	50000	12.06	56761
Oct-2010	14.14	5000	354	4500	55000	12.22	63640
Nov-2010	14.35	5000	348	4848	60000	12.38	69569
Dec-2010	13.52	5000	370	5218	65000	12.46	70560

Look at the column total investment and investment at current price. You can clearly see that total investment in the case of SIP is almost always lesser than the investment needed to buy the same accumulated quantity at current price.

This may not be true when the prices keep going down continuously. We know, however, that prices of mutual fund or stock do not go up or down straight. The short term ups and downs usually happen one after the other. SIP moderates the impact of these short term ups and downs of the mutual fund prices.

How to proceed with SIP:

You can ask your bank to allow a mutual fund of your choice debit a certain amount towards investment every month. You have to specify the amount, date of the month when money will be invested, and duration of SIP. For example, if you choose to invest Rs 3000, 10th of every month, for 3 years, the mutual fund will keep debiting Rs. 3000 from your account towards investment in the fund for 36 months.

You can also follow this on your own by investing Rs. 3000 every month. However you need to be very disciplined with your budget to achieve this.

Variants of SIP: Daily, Monthly

Daily SIP scheme requires investors to invest daily while monthly SIP allows

investors to invest monthly. At first glance, daily SIP seems to take care of volatility better than monthly SIP, but there is no empirical evidence that has shown significant difference in returns.

Key aspects:

1. Daily SIP is not allowed by many mutual funds and hence your options are limited. Monthly SIP options are available in almost all mutual funds.

2. The most important aspect is to do with our habits. We are used to planning for a month. It is more convenient for us to see income, investment, and expenses in a monthly timeframe and hence we can plan better towards a monthly SIP.

3. The final aspect is calculation of taxes. Daily SIP makes tax calculation more complex as you have to evaluate the capital gain by comparing the selling price with everyday price for the last 1 year.