It is considered a good practice to invest regularly. SIP is an approach where the investor invests constant amounts at regular intervals. A benefit of such an approach, particularly in equity schemes, is that it averages the unit-holder’s cost of acquisition.
Suppose an investor were to invest Rs 1,000 per month for 6 months. If, in the first month, the NAV is Rs10, the investor will be allotted Rs 1,000 ÷ Rs 10 i.e. 100 units. In the second month, if the NAV has gone up to Rs 12, the allotment of units will go down to Rs 1,000 ÷ Rs 12 i.e. 83.333 units. If the NAV goes down to Rs 9 in the following month, the unit-holder will be allotted a higher number of Rs 1,000 ÷ Rs 9 i.e. 111.111 units.
Thus, the investor acquires his Units at lower than the average of the NAV on the 6 transaction dates during the 6 month period – a reason why this approach is also called Rupee Cost Averaging. Through an SIP, the investor does not end up in the unfortunate position of acquiring all the units in a market peak. Mutual funds make it convenient for investors to lock into SIPs by investing through Post-Dated Cheques (PDCs), ECS or standing instructions.
Common sense suggests that “Buying low and selling high” is perhaps the best way to make money on your investments. But this is easier said than done, even for the most experienced investors. There are many factors at play when it comes to any market - debt or equity, and all of them are inextricably linked.
A simpler approach to long term investing is disciplining and committing to a fixed sum for a fixed period and sticking to this schedule regardless of the conditions of the market. Rupee cost averaging, as this practice is called, in a way ensures that you automatically buy more units when the NAV is low and fewer when the NAV is high. For Eg. a Rs. 1000 SIP gets you 50 units when the NAV is Rs. 20 but gets you 100 units when the NAV is Rs.10. The average cost for buying those 150 units would be Rs. 2000/150 units i.e. Rs. 13.33.
This discipline in turn suppresses the natural instinct to stop investing in a falling or a depressed market or investing a lot when markets are rising and buoyant. However, you should remember that the Rupee cost averaging does not assure a profit, nor does it protect you against investment losses in declining markets. It ensures that by disciplining your entry into markets, you override sentiments therefore reducing the risk of committing a fixed sum when markets are higher. Systematic Investment Plans offered by mutual funds are easily the best way to enter the world of investments over the long term.
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