An SIP or Systematic Investment Plan is a way to invest in mutual funds at regular intervals. In SIP method of investment, the investor has to invest a fixed amount in a particular mutual fund regularly, say monthly or quarterly.
The minimum period of investment is one year and mutual funds are sold in units. Investor can purchase the units at market rate for a fixed amount. For example, you can invest Rs 12,000 in a mutual fund at one time or you can use SIP and invest Rs 1,000 every month for 12 months (January 2010 to December 2010). If the net asset value of the fund on say January 7 was Rs 50 per unit, the investor will purchase 240 units of the mutual fund. However, if the investor uses SIP to purchase the mutual fund, the number of units purchased on January 7 will be 20. Every 7th day of the month, the fund house will sell the number of units worth Rs1,000 to the investor. The total number of units purchased under SIP will be 249 units (rounded off). Note that when prices are rising, the total number of units purchased under SIP would be lesser. If the market rates are falling, the investor will get a greater number of units for the same investment.
Some companies also have daily SIPs. Here the investor has to invest a fixed amount daily in the mutual fund. For example, Bharti AXA and IDFC permit daily SIP. If the market is relatively stable, the number of units purchased through daily SIP and monthly SIP will not vary much.
An investor can issue post dated cheques or give instructions to banks to release payment regularly.
Why should you invest in SIP?
SIP has several advantages for the investor. To begin, people who cannot afford to make lump sum investments and hence shy away from mutual funds can invest through SIP. SIP permits small regular payments and modest investors can use this method to invest in mutual funds. For example, it may be difficult to invest a lump sum of Rs12,000/ but it is more affordable to keep aside Rs 1,000 per month. Most mutual funds permit a monthly SIP investment of an amount as little as Rs500 per month.
Another big advantage of SIP is that it irons out the market rate fluctuations from your investment. Since units are purchased every month, the numbers of units purchased by the investor are more representative of the market rate. SIP has the benefit of averaging the purchase cost of the investment. If the net asset value falls in the following months, you actually stand to gain in the long run since you purchase more units of the mutual fund in contrast to if you make a single investment. SIP promotes regular investment. In addition one can also hold a diversified portfolio.
The minimum investment for SIP is Rs 500 per month in most cases. Hence if you have Rs 1500 to invest per month, you can purchase 3 mutual funds instead of one. A diversified portfolio reduces the risk factor of your investment.
Source: Yahoo Finance