Mutual Fund SIP: An Ideal Tool For Wealth Creation

Wealth creation is not easy. But neither it is difficult for wise and disciplined investors. One product that can really help investors in wealth creation is a mutual fund Systematic Investment Plan (SIP).

The SIP is a simple and time honored investment strategy for accumulation of wealth in a disciplined manner over long term period. This article takes a closer look at this very important and ideal tool for wealth creation for investors.

What is SIP?
The SIP is not a type of a mutual fund (MF) scheme. It is a way of investing in a mutual fund scheme. One can invest in a scheme by paying a Lump-sum amount or by making a Switch from an existing scheme or by doing a SIP, if available.

SIP is a very popular and an ideal way to invest as it leads to disciplined and regular investment for investors. It is just like a recurring deposit. Under a SIP, a specific amount, called as SIP Amount, is invested at regular interval of time, continuously for a certain period. Thus, for example, an investor may choose do an SIP of Rs.1,000/- every month for the next 5 years in a particular mutual fund scheme. Most of the schemes even offer the multiple choices of SIP date in a month to the investor.

Benefits of SIP:

Automatic Timing & Lower average cost of units:
One of very important benefits of SIP is that it does automatic timing of the markets. Under an SIP you will be investing a fixed amount every period, irrespective of whether the market is high or low. Thus, when markets are high, you would automatically buy lower number of scheme units and similarly when markets are low, you will be purchasing more number of scheme units. Thus, the SIP investors do not need to regularly track or worry about market movements. Further still, the average cost of one unit tends to be lower over time. benefit is also commonly known as “Rupee Cost Averaging’.

Illustration – Rupee Cost Averaging:
Say you have opted for an SIP in a diversified equity MF Scheme, investing Rs. 1000 every month from March 2010 to Feb 2011. Now if we check the average purchase cost per unit of your investments. It would be lower than the average NAV of your investment over 12 months.

Note: The table considers a hypothetical NAV trend to explain the concept of Rupee Cost Averaging. The NAV do not in any manner indicate the past or future NAVs of any scheme.

Average Cost = Total Cash Outflow / Total Number of units = Rs. 12000/ 85.80 = Rs.139.85
Average Price = Sum of all NAVs at which you have invested/ Number of months of investment = Rs. 1730/12 = Rs.144.17
Average Cost of Units < Average Price

Disciplined Savings:
Disciplined investing is an important characteristic to create wealth over a longer period of time. Often, investors plan to save in lump sum in some product and many are times such investments are delayed or do not materialize. SIP, with its disciplined way of investing, makes sure that you are saving money at regular intervals. Even small money, invested regularly, for a long period can go very long way in creating wealth. Think of each SIP payment as laying a brick. One by one, you will see them transform into a building.

Power of Compounding:
The famous scientist Albert Einstein called the “Power of Compounding” as the Eighth Wonder of the World. In simply means that the longer you invest, the returns will increase at a greater pace. Thus, the longer the SIP, the better the power of compounding will work for you and hence better chances for creation of significant wealth. Historically, SIPs have delivered good returns. The average returns for diversified equity MF scheme SIP and the power of compounding can be very clearly seen from the following table:

Actual data as on 31st January, 2011. Source: Internal. Past Performance may or may not be repeated in future. Returns are market dependent and are not guaranteed.

Planning for Financial Goals:
Due to its benefits of disciplined savings and attractive returns potential in long term, SIP can be very effectively used for planning your life and financial goals. Think of starting a SIP for your son’s education or daughter’s marriage or retirement. Your financial goals in life can become realistic if proper planning and use of SIP is done for same. The idea is to match the SIP period with that of the years remaining for any goal. Doing this can really help one plan out for financial goals smartly, even with small amounts of regular investment. This can be seen from the following example:

Table is for illustration purposes only. Past Performance may or may not be repeated in future. Returns are market dependent and are not guaranteed.

Convenience:
SIP can be operated by simply providing post dated cheques or with ECS. The cheques can be banked on the specified dates and the units credited into the investor’s account. The SIP facility is available in almost all of Equity, Balance & MIP schemes. Further, SIP can be started with amounts as low as Rs.500/, depending on the scheme. These conveniences also make SIP a very ideal investment vehicle for small & retail investors.

Thus, with the above benefits, it is no doubt that SIP is a true friend for investors in creating wealth. An investor should however know that the market is unpredictable and returns cannot be guaranteed. However, if one is investing wisely for a longer duration of time, it definitely will help the investor in reducing the risk of the market and making significant wealth. The tool is there. It is how you use it that really makes a difference for you.