Thursday, 2 June 2016

Benefits of Systematic Investment Plans (SIP)


SIP is a nonstop solution about averaging out your cost of investing and benefiting from power of compounding. You simply invest in the mutual funds monthly or quarterly over a period of time.

Imagine you are not feeling well, so you tried a medicine yourself but even after that you aren't felling better and it became worse.
So you went to a doctor , He gave you a medicine and after a day you were alright. 
The logic is you can't be a doctor yourself same way when it comes to investing in Mutual Funds, there are fund managers who do in depth research in stocks and buy the stock in their portfolio , so your investments doesn't go ill. 

Well, when it comes to SIP, the only thing that defines SIP is that it is a smart and hassle free mode for investing money in mutual funds. In more simple words, it is a method of investing a fixed regularly, sum, in a mutual fund scheme managed by professionals. SIP allows you to buy units on a given date each month. 

It is similar like EMI but the difference is, in EMI you have purchased the product may be a Home loan or car loan and then paying the money back to the lender and in SIP you have a Goal which could be near term goal like purchasing a car or world tour or a long term goal which could be buying a dream home, child’s education or retirement planning.

SIP is a planned approach towards the investments and helps you in dealing with the terms of savings and accumulating wealth for your future. 

How does SIP functions:

SIP is an easy going solution for all your problems.  It is a flexible and also easy investment plan that works in accordance with your goals. Your money is auto-debited from your bank account as the case in EMI, It is invested in the mutual fund scheme. In return, you are allocated a certain number of units that is based on the NAV rates. Thus, you can call this as a vehicle which has so much to offer in a disciplined manner. 

When you deal with SIP, the very first thing that you should know is the different NAV rates and the investor benefits from the Rupee-Cost Averaging and the Power of Compounding. 

Rupee-cost averaging: There are investors which remain skeptical about when is the best time to invest. The Rupee-cost averaging actually allows you in opting out the guessing game. So, if you are a regular investor, your money will get more units when the price is low and lesser when the price is high.

Below is an example of SBI Bluechip Fund SIP from 01/06/2015 to 01/06/2016

From the above image, An investor would have accumulated units 461.93 with an average price of 28.1725 and the current NAV price as on 01/06/2016 is 29.746
That average price is rupee averaging cost because when stock market was down you got more units since NAV was low and vice -e-versa .
Profit = NAV Price (As on Date) – Average Price X No of Units
               29.746 – 28.1725 X 461.93 = 740.57

Power of compounding: 
Albert Einstein quoted , "The most powerful force in the universe is compound interest." Compound returns offer one of the most powerful ways to build wealth. Compounding means earning interest on interest.. Mutual funds offer a similar way to capture compound returns.
Let us take an example
With simple interest, Interest is applicable the principal amount (that is, the amount you initially invested); with compounding, you earn interest on the principal and also on earned interest on the interest. To understand better, let's take an example.
Say you've invested Rs.10, 000 for 10 years and it makes 10% interest per year.

In case of simple interest, you will make Rs. 1000/- per year. At the end of the 10th year you will get back your principal of Rs. 10,000 and you would have accumulated total interest of Rs. 10,000.
In case of compound interest, in the first year, you make Rs.1, 000 in interest. But in the second year, you'll make Rs.1, 100 (not only does your initial investment of Rs.10,000 accrue interest but so does the additional Rs.1,000 you made in the first year). In the tenth year, you'll make Rs. 2,358. In 10 years, the power of compounding will grow your total investment of Rs. 10,000 to Rs. 27,070 as compared to only Rs. 20,000 in case of simple interest.
Now that you've understood the power of compounding, let's see how you can make that power work for you. Compounding will work for you if you:
This is very simple, the sooner you start investing, the more time your money has to grow. For example, if you started investing Rs. 10000 a month on your 40th birthday, in 20 years time you would have put aside Rs. 24 lakhs. If that investment grew by an average of 7% a year, it would be worth Rs. 52.4 lakhs when you reach 60.

How to use IRR in calculating the returns from SIP:
SIP involves the usage of cash at different time periods and then you actually get a large flow of cash at the end. In this way, you can actually use the IRR for the calculation of the return percentage from SIP.

You should calculate your returns in SIP using IRR which is an inbuilt formula in excel
Check the below image where in Investment(s) are made in 1000, it has been marked as – (negative) as it is the outflow per month and return is 13740

Why is SIP a smart choice ?
When it comes to get acquainted with SIP, the only first thing that comes to the mind is that it helps you in inculcating your financial goal. It helps you put your financial investment on the top priority and helps you save for your future. 

The key benefits which make SIP an essential tool are as follows:

Disciplined saving: This is a key to successful saving. You need to keep an assurance that you are saving every month with surplus cash you have.

Flexibility: There is flexibility in everything. You simply need to consider that while you are planning with SIP, there is no compulsion of continuing with the same plan. If you want to discontinue the plan and switch to another, then that’s available.

Long-Term Gains: When you are dealing with long-term gains, your SIP helps you in reaching your objectives and due to rupee-cost averaging and the power of compounding SIPs have the potential to deliver attractive returns over a long investment horizon.

Convenience: The SIP deals in providing a hassle-free mode of investment. You can also issue a standing instruction for your bank to actually facilitate auto-debits from your bank account.

Planning through SIP:

There are many reasons for choosing SIP but before that, you need to have a goal for what reason sip is started, it may be because of Short Term Goal or a Long term Goal.

Firstly, you need to list down your dreams and goals and work out a plan to achieve them through SIP

Secondly, you need to make sure the amount required for monthly/quarterly SIP is available to achieve your goals

There are so many schemes in Mutual Funds but before obtaining a scheme check your risk profile

Then there is a need to identify the scheme(s) in which you would like to invest and complete the formalities for SIP investment including forms and cheques

After this come the investment strategies for the long term which would provide you dual benefits of power of compounding and rupee-cost averaging work through different market cycles

And lastly comes the diversifying of your investments for your dreams through multiple SIPs in different schemes to optimize returns as per your needs.

Hence, the SIP is all about bringing discipline in the investment process. Hence, if one is learning to invest properly, the savings too will turn out to be very fruitful

So be a smart and informed investor – check how much insurance do you need and why you should in invest in Mutual Funds versus ULIP after analyzing the above two you can invest money via SIP in best 3 equity mutual funds in India for Retirement

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Disclaimer  :-
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