27 July, 2010

Why SIPs make sense...

You might have heard of the rabbit and the tortoise story. Some people are like rabbits – they save massive sums, when they decide to invest and they do get disillusioned at other times and withdraw the lot, in search of the next rainbow they see on the horizon.

As opposed to that the tortoise sedately keeps a low pace and keeps walking… and lo & behold, the tortoise wins in the tale! Just like it happened in Aesop’s fable, there are rabbits & tortoises in real life too. There are those who believe in big bang investments who also make quick silver exits, like the rabbit. And there are others who believe in the boring way to investments – investing small sums regularly.

Such regular investments in Mutual Fund schemes have been called Systematic Investment Plan or SIP by the MF industry. Here small sums of money are regularly invested, typically on a monthly or quarterly basis, over a long period. There are several advantages of making such regular investments. Here are some –
Tighten your belt – Monthly investment of a fixed amount brings in discipline into your fiscal behavior. Since the amount gets deducted from your bank account automatically, you do not even realize it. This inculcates a savings habit, forces you to save and brings in a regularity in your investment pattern .

Timing risk is eliminated – By investing a fixed sum every month, you can make the timing risk irrelevant… for, when the market is high, you invest the same amount and get allotted a lower number of units and when the market is at a low ebb, you get allotted a higher number of units for the same quantum of investments. This is also called Rupee Cost Averaging. It is so named as your average cost of acquisition tends to be lower than the average sale price, over time. The only thing is that the broad longterm trendline of the markets should be upward. In our economy, it is very much so. The other risk is volatility. This works very well when there is volatility in the markets

Buying when it is low, we all understand, is the correct way to invest. But when the market is low, we seldom invest – for fear grips us and prevents us from doing the sane thing. SIP ensures that we get this right.

Convenience - The monthly investments can go directly from your bank account, taking the pain out of investing. By putting it on auto-pilot, you do not have to remember to issue cheques, nor miss out a cycle because you have just forgotten to invest, in a given month. Best for those with time constraints – which is all of us today!

Works well over long periods – Over long time frames, SIPs ensure that the average cost of investments come out lower as compared to market prices prevailing at a future point. Hence, inspite of short-term fluctuations and turmoil, you would be able to still get good returns, if you stay invested for long periods. For instance, Rs.1000/- invested in HDFC Top 200 Fund, gave a compounded return of 28.28%pa since inception ( 1996 ), 33.11%pa over a 10 year period and 24.52%pa over a 5 year period… not bad at all, considering there were couple of huge upheavals in 2000 and again in 2008. These are excellent long-term returns, any which way you look at it.

Power of Compounding – Getting to stupendously large sums over time seems incredible. It is simply the power of compounding. Albert Einstein called it the eighth wonder of the world. A small sum of money grows ino a huge sum over a long period, as the interest earns interest, over time. For instance, a Rs.50,000/- one-time investment grows into Rs.8.72 Lakhs, over a period of 30 years at a 10% pa returns. From your perspective, it is a sure-fire way to get to seemingly impossible sums of money, while investing driblets.

No need to wait to accumulate big sums – Since SIPs can be done for as low as Rs.500/-, you now have little justification to postpone investing, till you accumulate a big sum to invest. In fact, by waiting to accumulate a big sum before investing, you run the risk of spending the money being accumulated. SIP will address this problem squarely.

Reaching Financial Goals in a painless manner – If you have set sights on a car or simply want to plan a comfortable retirement, you could choose to invest small sums regularly and reach your goals effortlessly. For instance, to accumulate a retirement corpus of Rs.1.5 Crores after 28 years, assuming a return of 1% pm, you would need to contribute an amount of Rs.5,438/-pm, over this period. Now, that is not such a big deal, is it?

You might have thought that the suave, clued-in guy in your office, who is regarded as an investment guru, is a privileged one with investment acumen and timing genius. Well, he might be. Good for him. But, with SIPs, your returns are going to be the envy of the rabbits. Be the tortoise – it may be unglamourous. But, it wins races. You can too!

Published in DNA Money on 27/7/2010

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