The Magic of SIPing

"The Magic of SIPing" has been published in BLOG M, a blogazine. It has also been judged as the second best article of the December edition.

How about sipping a hot cappuccino on a chilly evening, isn’t it magical.  But here we won’t be sipping a cappuccino, instead we will be talking about the magical increase in your wealth by investing in mutual funds through the SIP (Systematic Investment Plan) route. So SIPing here means “Investing  through SIP”. Investment is a matter of discipline. Those who invest regularly in a disciplined manner never loose. But again a question comes back to our mind that –What is discipline in investments? 

It simply means investing a fixed amount of money at regular intervals say a quarter or a month, with a clear financial goal in mind.  This regular investment averages out the purchase cost per unit(rupee cost averaging). It is always better to be disciplined while investing rather than making irregular investments by trying to time the markets and judging its highs and lows. This discipline in investment can be achieved by going through the route of Systematic Investment Plan (SIP). An SIP can be started with an amount as low as Rs.500 in an open ended scheme of a fund house. In order to explain how the concept of rupee cost averaging actually works and creates magic, I will take the help of two of my friends – Mr. Smart and Mr. Oversmart.

Mr. Smart invests in a disciplined manner, without timing the market and without relying on the market rumours. On the other hand, Mr. Oversmart, invests only on the basis of tips from his friend and tries to predict the highs and lows of the market. Mr. Oversmart and Mr. Smart, both want to invest Rs. 40,000 in a mutual fund scheme over a period of 4 months. 
Mr. Smart has opted for an SIP of Rs. 10,000 each month for 4 months. The NAV of the fund for 4 months is Rs. 20, 18, 22 & 25. By investing Rs. 10,000 each month, Mr. Smart receives 500, 555.50, 454.50 & 400 units respectively each month. In all, he receives 1910 units and the average price per unit comes out to be Rs. 20.94, which is on a lower side when compared to the NAV range of Rs. 18 to Rs. 25. 
 On the other hand, Mr. Oversmart, who times the market and waits for the NAVs to touch their bottoms, did not invest anything in the first 2 months when the NAV was Rs. 20 and 18, expecting it to fall further. But in the third month, the NAV rises to Rs. 22, then getting the feeling of having missed the bus, he invests Rs. 20000 @ Rs. 22 and receives 909.09 units and next month as the NAV touches Rs. 25, he further invests the remaining amount of  Rs. 20,000 @ Rs. 25 and receives 800 units. Thus, Mr. Oversmart receives  a total of 1709.09 units and the average cost of purchase comes out to be Rs. 23.40 per unit, which is higher than the average price of Rs. 20.94 of Mr. Smart’s units.

Be a smart investor and not an oversmart investor. A disciplined investor like Mr. Smart never loses, he always enjoys a win-win situation as the cost of investment gets averaged out during the tenure of the investment, thus minimizing the impact of rise and fall in markets. This clearly demonstrates the magic of SIPing. So keep investing in a disciplined manner to maximize your wealth, after all its your hard earned money which is at stake and money matters a lot.

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Share your views...

7 Respones to "The Magic of SIPing"

Parth said...

Agree with the author that SIPs are the best source of investments as far as safety is concerned. But what if the market prices in four periods were reversed?? That is, 25 22 18 and 20??

December 20, 2010 at 1:55 AM
Nandan Narula said...

@ Parth : welcome to MONEY MATTERS. There can be 'n' number of "What IF "situations , but the question is that how can we predict the price movements? So for a retail investor , its much better to stop thinking about the ups and the downs and follow a disciplined approach , n m sure that this approach will benefit u a lot in the long run.

Parth said...

@ Nandan.. Thanx for the warm welcome.

As my opening line suggests, I am always in the favour of SIPs. But i really feel this example is a bit sketchy. In addition to my above comment, one should also give effect of present value concept in the said example. Oversmart invested in 3rd period. But it is possible that he might have earned something on that amount in last two periods. That effect is to be given while averaging out.

And one more bad thing i feel is in the SIPs is, they are longterm instruments.. Offering hardly any liquidity.. As tricky compounding principle is the underlying magic stick in SIPs, one always feels a loser in redeeming the units..

December 21, 2010 at 3:50 AM
Nandan Narula said...

@ Parth : Talking about the Oversmart investor, who was trying to time the market, had he invested before the 3 rd period then his investment would have been for less than 2 months and such very short term investments would make him a trader rather than an investor.
regarding the SIP, yes, in case of SIP in Equity or balanced funds , it should be there from a long term prospective only, but i dont think that there is a liquidity problem. The units which u received through the SIP route can be easily redeemed or sold. And of course if the investment is made in an underperforming fund, then neither SIP nor any other magic wand can generate decent returns

Parth said...

@ Nandan, sorry but your first paragraph went over my head.

And regarding liquidity, my argument is different. Look in SIP, if u continue investing Rs. 1000 p.m. from Year 1 to Year 2, u will earn good returns.. BUT, if u continue investing same Rs. 1000 p.m. from Year 23rd to Year 24th, u will earn so much return in just that one year that u might not have earned in Year 1 to Year 10 taken together.. (Difference between NAV @ 24 and NAV @ 23 will be such large)

Getting my point?? This is what makes decision-making tricky.. Because of compounding, the opportunity cost of opting out of the scheme keeps on increasing..

December 22, 2010 at 12:26 AM
Nandan Narula said...

The first paragraph says that if u r looking for a very short term propective, then u ll be classified as a trader and not an investor, whereas SIPs are only for investors.
Wrt ur above set of numbers, kindly re-submit the details coz i see some mistake as a u are talking about 'Year 23rd and Year 24th" which is an excessively long period

Parth said...

Still the thing is not clear to me. Had he invested before 3rd month, he would've longer retention period!! If u want to say "after" 3rd month, then u can be right that the period will be less than 2 months.. But how the period can reduce if invests before hand!!

And the period is not excessive. Any young one who starts investing at 24-25 will have such longer planning in his mind.. But still if u want me to make things simpler for u, then u take one hypothetical example. (Cont.)

December 27, 2010 at 5:01 AM

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