FundsIndia Explains: Why SIPs are more than just cost averaging
SIP, or Systematic Investment Plan, is often touted as the best way to invest your money in Mutual Funds. Many new investors think SIPs are a type of investment. It is not. It is one of the ways to invest in mutual funds. SIP allows you to invest a fixed sum of your choice in a predetermined frequency, like weekly or monthly.
Since SIPs keep investing in funds at a regular periodicity, they buy MF units for you at different prices. Therefore, they help you average costs across market cycles. This means you sometimes buy when the unit prices are high (when the market is going up) and sometimes when unit prices are low (when the market is falling). This is how SIP effectively averages your cost. But there’s more to SIPs.
Apart from the purely mathematical advantage of cost averaging, SIPs offer more benefits that help you amass a higher corpus. In reaching your financial goals, SIPs can help you in more ways than one. Here a few ways in which SIPs help you become a better investor.
- SIPs keep your savings rate high
SIPs usually require a one-time mandate to make sure your investment is made every month or in the periodicity determined by you. This automates the investment process, ensuring that you don’t have to draw a cheque every month. Once the process is automated, whether the market falls or rises, you will continue investing. You will also continue investing when you are out on a vacation or embroiled in a stressful situation at work. And because it is automated, your savings remain steady.
When you have to make transactions manually, there are a number of reasons you can miss it. Most of us don’t even realise when we miss one or two installments. In the end, you end up saving far lower than what you have ideally liked to and therefore often miss your goals because you didn’t regularly invest. That a SIP investor saves higher is reflected in our investor behavior too.
We looked at some data related to Fundsindia investors who registered in the year 2016. This analysis was done for retail investors (non-HNIs). We saw that the total amount invested by them was 13.6% higher compared with people who did not set up SIPs. In other words, your saving is higher and investment habit is more effective when you invest through SIP.
- SIPs make your goals achievable
Imagine you expect your child to pursue an MBA in the year 2028. You estimate that this course will cost Rs. 30 Lakh in 2028. When you look at this number, it may look daunting. For some, it might make them wonder if it is even possible to achieve those.
However, if you take an asset allocated portfolio and invest in it on a monthly basis, you will need to invest only Rs. 12,500 per month. This small amount, invested every month, will ensure you reach your goal on time. If even this amount looks big, you can start with Rs. 10,500 and increase your investment by Rs. 500 every year and still reach your goal comfortably.
So a SIP breaks down your dreams and aspirations into smaller installments that make the larger goal seem achievable. It thus encourages you to take a step instead of giving up at first sight.
- SIP ensures you save and then spend
What happens when you have money in your bank? You spend. If you plan to make your investments manually every month, every time you have an unplanned expense, you will postpone your investments. Setting up a SIP ensures you do not cancel your investments at whim. You will rather control your expenses to make sure your bank account balance is sufficient for all the installments.
The discipline of investing through SIP teaches us to control our discretionary expenses. If your SIPs are scheduled for the 10th, your investments will be made on the 10th. Any expenses coming up after that will require some thought. When you don’t have the money in your bank account, you can’t instantly whip out your debit card to pay for it. Thus SIPs put a stop to impulsive spending.
There’s more to SIP than just cost averaging. SIPs ensure that you invest without breaks. Over a long period, this will ensure you end up with a higher corpus than you otherwise would. Your financial goals will be within your reach and you will never stress about market fluctuations. So start your SIP today.
