SIP is a three-letter word giving another three-letter word, IPO, a run for its money
You want to invest in the share market yet prefer to play safe? Mutual Funds have solved the dilemma to some extent, as they cut down the risk of investing in shares. A form of collective investment, a mutual fund is a pool of money made from many investors and the money is invested in several different stocks. The fund manager collects the income from these investments on behalf of investors, passing the proceeds to them regularly. The value of a share of the mutual fund, known as Net Asset Value (NAV), is calculated daily based on the total value of the fund divided by the number of shares purchased by investors.
One option is to invest a lump sum in a mutual fund. The other option is to invest regularly through a Systematic Investment Plan (SIP), a scheme where you can periodically invest a fixed sum, which could be as low as Rs 500 per month. Considered as one of the ideal low-risk methods of wealth accumulation, SIP helps investors overcome the fluctuations of equity investment. Some consistently performing mutual fund companies include HDFC, Franklin India, Reliance Mutual Fund, Birla Advantage, UTI Balanced, Kotak, ICICI and Morgan Stanley.
How does SIP work?
Reduces the average cost
Investing through SIP makes timing and cycles of the share market totally irrelevant. With SIP, you invest a fixed amount regularly. Therefore, you end up buying more units when the markets are down (when the NAV is low) and less units when the markets are up (when the NAV is high). This is called rupee-cost averaging. SIP works as a disciplined investment method as it forces you to buy even when the markets are low, which is actually the best time to buy. Let us understand this concept through an example:
Month Amount invested (Rs) NAV No. of units
1 1000 10 100
2 1000 9 111.11
3 1000 10 100
4 1000 11 90.9
Total investment = Rs 4,000,
No. of units purchased = 402.01
Therefore, average cost per unit = Rs 9.95
Does away with the need to time the markets
As your investment is spread across a longer period of time, it helps to average out market swings. This leads to spreading your investments over various time horizons, which enhances the probability of lowering your total cost. This translates into better returns. But you must remember that, ultimately, markets do matter. All that a mutual fund company does is cushion your losses on money invested in the markets by putting it in a variety of stocks like petroleum, entertainment, agriculture, pharmaceuticals, to name only a few of them-the final choice is yours.
UNDERSTANDING GAINS FROM SIP
Suppose you start investing 35 (age) 40 (age)
in a diversified equity mutual
fund through an sip at
Your monthly investment Rs 5,000 Rs 5,000
You stop investing at age 60 60
Your total contribution Rs 15,00,000 Rs 12,00,000
Assuming compounded
annualized returns from
the fund are 15 per cent,
your savings could grow to Rs 1.37 crore Rs 66 lakh
Does not strain your finances
Mutual funds allow you to invest very small amounts (Rs 500 to Rs 1,000) via the Systematic Investment Plan route. SIP makes investing easier as it does not strain your monthly finances. In fact, this is ideal for working professionals and retired persons who would otherwise not be able to enjoy the benefits of investing in the equity market. In addition, you can change the duration of your SIP midway, withdraw money, even change plans and the company.
Power of compounding
SIP is a time-tested investment approach that helps you increase your returns through the concept of 'power of compounding'. The longer the period of investment, the more you accumulate because of the compounding effect of returns on your investment. In simple terms, it works on the principle of interest on interest. Whether you invest for short-term goals or long-term ones, the earlier you start and the longer you stay invested, the better.
Mutual fund investments are subject to market risks. Make sure you read the offer document before investing and take advice from an investment planner
5 mental hurdles to overcome
You've read good things about mutual funds, but for one reason or another you fail to trust your hard earned rupees to them. Let us play investment psychologists and help you overcome five common mental hurdles.
1. I don't have enough to invest in a mutual fund
Mutual funds are the ideal place to invest small amounts of money because you can buy a mutual fund without direct trading costs. For example, if you put Rs 1,000 into a stock each month for a year, you will end up paying at least Rs 135 in commissions to a broker. So out of Rs 12,000 invested, only Rs 10,380 goes to work for you-an automatic loss of 13 per cent. But when you invest Rs 1,000 a month directly with a fund, the entire Rs 12,000 goes to work!
2. I don't want to risk investing in non-guaranteed investments.Mutual funds are safer than you think. Mutual fund prices are driven by the price changes of the securities it holds-the fund is only as risky as the type you choose. Banks and insurance companies can go bankrupt but, by definition, mutual fund companies cannot. Once you understand inflation, average returns of different types of investments and compound interest, you may realise you are taking a bigger risk by tying your money up with low-producing products like savings accounts.
3. I can do better by picking stocks on my own A dedicated team of professionals is better than a single individual picking stocks.
4. I will invest in my company's stocks. It's better Your job is already tied to your company-if the company crashes, don't let your retirement plans crash as well. The beauty of a mutual fund is that you don't need to be an expert on the thousands of stocks that it buys. Diversification (investing in various types of stocks) helps keep your returns up and risk down.
5. I don't understand how mutual funds work, so why should I invest in them?
Investing in mutual funds is not hard. It can be as simple as filling out an application and mailing it in with a cheque. However, knowledge is power and if you desire to understand mutual funds and make smart investing decisions, call an agent now.
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