Mutual Funds: How does SIP work ?
Updated: Sep 6, 2020
Little drops of water make the mighty ocean, similarly investing through mutual fund SIP (Systematic Investment Plan) can help you create a large corpus. Before we start, please note that SIP is only a mode of investing in mutual funds. In mutual fund SIP a specified amount will be deducted from your account on particular day on weekly or on monthly or quarterly basis. Investment in mutual funds through SIP mode helps bring discipline in your investment and helps you to average out buying price of mutual fund units.
Suppose market price of stock "XYZ" is Rs 1000 per share, so with Rs 1000 you can invest in only share of that stock. But if you invest
Rs 1000 in a mutual fund scheme, then your money will invested in "XYZ" stock plus other stocks. Thus mutual funds help you achieve diversification in your investment by investing a small amount.
Let us see how Mutual fund SIP (Systematic Investment Plan) investment works.
There are three friends Sachin, Saurav and Rahul, all three want to invest Rs 12000 in a particular mutual fund. One year chart for that mutual fund indicating NAV on 1st day of each month is indicated below.
Sachin 's decides to do SIP investment of Rs 1000 per month in mutual fund. SIP table for Sachin's investment is shown below.
Sachin thus invests Rs 12000 over a year and is allotted with total 1123.24 mutual fund units with average NAV price of 11.15.
Saurav invests Rs 12000 in month of January and is allotted with total 1200 mutual fund units with NAV price of 10.
Rahul invests Rs 12000 in month of August and is allotted with with total 1008.43 mutual fund units with average NAV price of 11.9.
Now if we analyze the performance of the three friends,we see that Saurav's investment has appreciated in value by 14% because he invested in mutual fund when NAV of mutual fund was lowest in month of January. At same time Rahul 's investment has depreciated by 4.2% as he invested in month of August when NAV was highest.
NAV of mutual fund is directly linked to performance of stock market, thus NAV of mutual fund will be highest when market is at its peak and lowest when market reaches its bottom. To get highest returns one must invest when market is at its bottom and avoid investing when market is at its peak. But it is not easy even for experts to calculate peaks and bottom of stock market. If we keep waiting for market to bottom out while investing, we may end up missing the market rally. Stock markets are volatile, so it recommended you invest through SIP mode.
Sachin invested regularly through monthly SIP and his investment appreciated by 6.71%. He ended up buying mutual units at various price levels so his average cost of buying each mutual fund unit was lower than Rahul's cost, but higher than Saurav's cost. Sachin's returns were lower than Saurav's return, but as we discussed earlier it is difficult to correctly gauge when market will hit the bottom. Sachin does not have to invest Rs 12000 at one go and also there is no need to worry about market's peaks and bottoms.
SIP investment in mutual fund thus averages your cost of investment which in turn reduces your overall risk.
Our opinion Systematic Investment Plan
Invest a specific amount monthly through SIP mode, this will bring discipline in your investments. Use mutual fund SIP's to save money for your life goals like buying a house,new car,children's education and marriage etc.
If you are new to equity mutual funds then first start with investment in tax saving mutual funds (ELSS) .
If you get any windfall gains like annual bonus, then invest the amount in any liquid mutual fund and use STP(systematic transfer mode) mode to transfer a specified amount into equity mutual funds.
If there is any sharp fall in stock market then use the opportunity to do lump-some investment in mutual funds.
FAQ about SIP investment in mutual fund are listed below
What is the minimum amount one can invest in mutual fund through SIP ?
You have to invest minimum Rs 500 per month and in multiples of 100 there after.
What is the minimum period for SIP investment ?
You have to invest for minimum 6 months to invest through SIP mode.
Can I select date on which SIP amount will be deducted from my account.
Yes. Mutual funds usually offer four date options for SIP amount deduction. (example 7th , 10th , 15th & 20th of the month). You can select date of your choice while registering for SIP. If in a particular month if selected date falls on holiday then amount will be deducted on next business day.
SIP date options vary depending on mutual fund house selected for investment.
What are the various modes for investment through SIP?
You can invest through post dated cheques,ECS (Debit Clearing), Direct Debit Facility and Standing Instruction.
What are the documents required for SIP investment?
You need to provide KYC documents alongwith SIP application form. KYC documents include PAN card,address proof and identity proof.