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Saturday, October 9, 2010

4 Good Reasons For Investing Through SIPs

Below are the 4 good reasons for investing regularly through SIPs:

1. Light on the wallet

Given that the average annual per capita income of an Indian citizen is approximately only Rs. 25,000 (i.e. monthly income of Rs 2,083), a Rs 5,000 one-time entry in a mutual fund may still appear high (2.4 times the monthly income!). And, mutual funds were never meant to be elitist; far from it, in fact the retail investor is as much a part of the mutual fund target audience as the next high net worth investor (HNI). So, if an investor cannot invest Rs 5,000 in one shot, that's not a huge stumbling block, the investor can simply take the SIP route and trigger the mutual fund investment with as low as Rs 250 per month.

2. Makes market timing irrelevant

If market lows give you the jitters and make you wish you had never invested in equity, then SIPs can help. Plenty of retail investors are not experts on stocks and are even more out-of-sorts with stock market oscillations.

But, that does not necessarily make stocks a loss-making investment proposition. Studies have repeatedly highlighted the ability of stocks to outperform other asset classes (debt, gold, even property) over the long-term (at least 5 years) as also to effectively counter inflation. So, if stocks are such a great thing, why are so many investors complaining? It's because they either got the stock wrong or the timing wrong. Both these problems can be solved through an SIP in a mutual fund with a steady track record.

3. Power of Compounding

The early bird gets the worm is not just jungle folklore. The same stands true for the 'early' investor, who gets the lion's share of the investment booty vis-à-vis the investor who comes in later (see table below). This is mainly due to a thumb rule of finance called 'compounding'.

So as we see, Ram starts at age 25, and invests Rs. 7,000 per month until retirement (age 60). His corpus at retirement is approximately Rs. 2.65 crore. Mohan starts at age 30, a mere 5 years after Ram, and invests the same amount until retirement (also at age 60). His corpus comes to approximately Rs. 1.58 crore, note the difference between the 2 corpuses here.

And lastly, we have Kunal, the latest bloomer of the lot. He begins investing at age 35, the same amount monthly as Ram and Mohan, and invests up to his retirement (also at age 60). His corpus is, in comparison, a meagre Rs. 92 lakhs.

So the earlier you begin your SIPs, the better returns you get. This is simply because of compounding returns your investments will receive over more no. of years.

4. Lowers the average cost

SIPs work better as opposed to one-time investing. This is because of rupee-cost averaging. Under rupee-cost averaging, an investor typically buys more of a mutual fund unit when prices are low.

On the other hand, he will buy fewer mutual fund units when prices are high. This is a good discipline since it forces the investor to commit cash at market lows, when other investors around him are wary and exiting the market. Investors who kept their SIPs going while the Sensex fell from 21,000 to 8,000 in 2008 and sitting on some significant profits now, because they kept up their investing discipline.

The above table explains the absolute returns generated by SIPs in the respective time frame. For investment in some large cap funds, SIPs on an average have delivered absolute returns of 53.2%, 35.0% and 20.2% over 1-yr, 2-yr and 3-yr periods.