Posted in Finance Articles, Total Reads: 4740
, Published on 08 February 2011
Recently when I was reading a magazine I read a story of Chinese Bamboo which tried to relate and explain the significance of Systematic Investment Plan (SIP) in financial market. The story went something like this that in small village there lived a farmer who has a meagre income. One day he met a wise man seeking advice on how to improve his income. The wise man asked him to cultivate Chinese Bamboo. So obeying the wise man the farmer cultivated Chinese Bamboo for a whole year but nothing happened. The same thing he did the second year and still nothing happened. Though disheartened he continued for the next 3 years as well. After 5 years, the bamboo sprouted and grew quickly in the no time yielding him high returns. Thus the farmer became rich. The SIP also works on the same principle which is that an investor will earn unbelievable returns in the long run.
SIP is a manner of investing money in the market in such a way as to take advantage of volatility in the market and thus deriving maximum returns on the investment but over a longer period of time. In SIP, the investor invests a certain amount at pre specified intervals at the prevailing NAV. By investing in such a manner, the investor could end up owning more number of units and could get more returns when finally disposes off those units. There is a reduction in the average cost of each unit provided there is volatility in the market.
Now let us assume that the investor is investing a fixed amount of 500 every month in SIP. When the market price falls he can buy more units and is shielded when the purchasing price is less.
The total investment in the last 5 months is 2500 and the number of units allotted during the time is 250.45. The average NAV during the period comes up to around 10.2 whereas the NAV for the investor is 9.98. So we have considered a short period and hence the returns does not look much but in the long run as explained by the Chinese Bamboo story, the SIP would provide good returns for the investor.
The Benefits of Systematic Investment Plan is as follows
1. Market Timing Irrelevant: One of the biggest problems of investing in equity is the volatility of the market. The two major questions for any investor is to decide when to enter the market and where to invest the money.
Mutual funds help in taking care of where to invest and SIP helps in taking care of where to invest.
2. SIP is transparent and well regulated: The SIP investments are well regulated and hence it is safer and convenient for investors to invest.
3. Reduces the average cost: In SIP the investor invests a fixed amount of money every month. He receives lesser number of units when the price is high and higher when the price is low. This is also called rupee cost averaging. SIP works as a good discipline as it forces us to buy even when the markets are low.
4. Light on the wallet: It is a good investment option for a small time investor because they can invest as low as 500rs every month. So it necessarily does not strain the day to day finances of the investors.
5. Diversified Portfolio for investor: Another advantage is that even though small amounts are invested we can enjoy the benefits of diversified portfolio. This would not be possible for an individual investor as it required huge resources.
Thus an investor who does not have huge amounts of money to invest in the equity market should always consider SIP as the monthly commitment for the investor is well within the reasonable limit. Thus the SIP ensures that the individual does not look at the market for short term gains but stays invested for long term benefits. So regular investment in the form of SIP will help the investor to overcome the market volatilities and plan his investments better.
About the Author : The author is a consultant with a finance firm. Views are personal.
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