What is CMP in the Stock Market?
In previous times, the stock market was a physical space that traders set up offices and desks at, and stocks, shares and bonds were traded in physic…
14 Jun, 2021
8 min read
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Everyone has heard of SIP by now because it has become quite a commonly quoted term – even if it isn’t always used correctly.
You might have heard colleagues talking about it when the office accountant distributes tax declaration forms or you might have been recommended SIP as a mode of investment.
So let’s have a look at what SIP is. Actually, let’s start with what SIP is not.
A lot of people refer to SIP as if it were a type of investment like fixed deposits or stocks. However calling SIP a type of investment is like responding to the question “What is your exercise routine?” with “daily” instead of talking about the type of exercise you do on a daily basis. SIP is a mode of investment, specifically in mutual funds. A Systematic Investment Plan, abbreviated as SIP is the opposite of a lump sum mode of investment in mutual funds. When you invest a lump sum, you invest the entire capital for your investment in one go. When you invest in an SIP, in contrast, your capital is invested gradually: a fixed sum, on a fixed date, in a fixed mutual fund is invested versus making the investment in one shot.
You might compare it to paying for a purchase upfront, versus paying for it in installments.
So why do people opt for investing in mutual funds via SIP rather than lump sum investment? Do they see some benefit in it? Yes, in fact there are several benefits, such as:
1. Rupee cost averaging
When you invest in a mutual fund, you buy units of the said mutual fund. So let’s say you have Rs 5,000 to invest. You will receive how many ever units are possible within that amount. Let’s say the price of ABC mutual fund’s units is Rs 25; you will get 200 units with your Rs 5,000 investment capital. However, the price of a mutual fund’s units vary on a day to day basis. This is somewhat like stocks in the fact that the price is variable, but different in the sense that unlike stocks whose prices fluctuate by the minute, a mutual fund’s price only changes from one day to the next.
You earn based on the price difference of your units when you buy versus their value when you day
When you look to buy into this type of investment, you’re looking to buy at as low a price as possible and sell at as high a price as possible. However, as an amateur investor who already has a job, you probably haven’t got time to scour the market for the prices of various mutual funds on a daily basis. That’s when this staggered style of investing comes in. By investing a fixed amount on different dates you could admittedly get fewer units on some days but you could also get more units on some days; or in other words your price averages out.
As a result, when you opt for an SIP you will typically have the fixed amount debited on a fixed date every month to a fixed mutual fund house.
2. Suitable for those you accumulate small, gradual savings
For investors who are only able to put aside a small chunk of savings from their monthly salary, rather than big amounts, this mode of investing is a huge boon. Otherwise they might have to wait for 10 months or a year to accumulate sufficient savings for an investment, earning very little interest in their savings accounts. In this way, even their small amounts can have the potential of earning interest that one can be excited about.
3. Can be useful to inculcate a savings habit
People can have their SIP amount for their mutual funds direct-debit such that the amount is invested before they have the time to finish off their entire salary on a shopping binge. This can help even the most compulsive spenders develop some savings.
That said, you might want to also consider the following
4. Leaving things to chance
When you’re investing on a fixed day, you cannot foretell what the price of the mutual fund’s units will be that day? In other words, you are leaving things to chance. It is possible that the unit price is rarely low on the day that you have signed up to buy, but what if the price is often high on your designated SIP day every month?
5. When you have a windfall
Let’s say you have just received a bonus or an inheritance or some large chunk of capital? It does not make sense to keep it in your savings account and have small amounts invested every month. You do not want to lose out on potential earnings while your capital is tied up in your savings account. Even if you pay a potentially higher price for your units, it could work out better than letting your capital earn a low amount of interest in your savings account.
Gradual withdrawal could be a benefit or a downside
If the mutual fund investment that you have chosen has a lock-in period, you will also need to make gradual withdrawal, or you will need to wait till the last installment matures before you can redeem your entire investment. For example, if you invest Rs 5,000 via SIP into ABC mutual fund, for 3 years, starting May 1 2021, by May 2, 2024, you can take out the first Rs 5,000 but no more, because there is still time for the subsequent installments to mature. The last installment that you made, on April 1, 2024, can only be redeemed in April 2027.
However this might also double up as a positive for those who are looking to arrange for a sustained income after the maturity of their mutual fund investment. In fact some people voluntarily opt for a SWP – or systematic withdrawal plan – rather than lump sum withdrawal because that way, they get additional monthly income. Or if they are retired, they continue to get a monthly income.
Start your investing journey with Angel Broking. Remember that anyone can invest irrespective of age, gender or occupation. All you need to do is sufficient research and homework – just like you’re doing now. Keep it up!
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