The importance of Systematic Investment Pan.
The strategy and/or plan of investing at regular intervals is just as applicable to mutual funds as it is to common stock. Establishing such a plan can substantially reduce your long-term market risk and result in a higher net worth over a period of ten years or more.
A Technique that Drastically Reduces Market Risk
Systematic Investment Plan is a technique designed to reduce market risk through the systematic purchase of securities at predetermined intervals and set amounts. Many successful investors already practice without realizing it. Many others could save themselves a lot of time, effort and money by beginning a plan. In this article, you will learn the three steps to beginning a Systematic Investment Plan plan, look at concrete examples of how it can lower an investor’s cost basis, and discover how it reduces risk.
Systematic Investment Plan: What is It?
Instead of investing assets in a lump sum, the investor works his way into a position by slowly buying smaller amounts over a longer period of time.
This spreads the cost basis out over several years, providing insulation against changes in market price.
Setting Up Your Own Systematic Investment Plan Plan
In order to begin a Systematic Investment Plan plan, you must do three things:
Decide exactly how much money you can invest each month. Make certain that you are financially capable of keeping the amount consistent; otherwise the plan will not be as effective.
Select an investment (index funds are particularly appropriate, but we will get to that in a moment) that you want to hold for the long term, preferably five to ten years or longer.
At regular intervals (weekly, monthly or quarterly works best), invest that money into the security you’ve chosen. If your broker offers it, set up an automatic withdrawal plan so the process becomes automated.
An Example of a Systematic Investment Plan Plan
You have Rs15,000 you want to invest in XYZ Stock common stock. The date is January 1, 2000. You have two options: you can invest the money as a lump sum now, walk away and forget about it, or you can set up a Systematic Investment Plan plan and ease your way into the stock. You opt for the latter and decide to invest Rs1,250 each quarter for three years. (See chart for math of Systematic Investment Plan plan.)
Had you invested your Rs15,000 in January 2000, you would have purchased 264.46 shares at Rs56.72 each. When the stock closed for the year in December of 2002 at Rs13.69, your holdings would only be worth Rs3,620!
Had you Systematically Invested (thru SIP) into the stock over the past three years, however, you would own 746.21 shares; at the closing price, this gives your holdings a market value of Rs10,216. Although still a loss, XYZ Stock must only go up to Rs20.10 for you to break even, not Rs56.72, which would have been required without the Systematic Investment Plan.
To go a step further, without Systematic Investment Plan you would break even at Rs56.72. With Systematic Investment Plan, you would have turned a profit of Rs27,326 when the stock hit that price thanks to your lower cost basis (Rs56.72 sell price – Rs20.10 average cost basis = Rs36.62 profit x 746.21 shares = Rs27,326 total profit.)
Combining the Power of Systematic Investment Plan with the Diversification of a Mutual Fund
Index funds are passively managed mutual funds that are designed to mimic the returns of benchmarks such as the S&P 500, the Dow Jones Industrial Average, etc. An investor that puts money into a fund designed to mimic the Wilshire 5000, for example, is literally going to own a fractional interest in every one of the five thousand stocks that make up that index. This instant diversification comes with the added bonus. Traditionally, management fees of passive funds are less than one-tenth those of their actively managed counterparts. Over the course of a decade, for example, this can add up to tens of thousands of Rupees the investor would have paid in fees to the mutual fund company that, instead, are accruing to his or her benefit.
The Systematic Investment Plan component reduces market risk, while the index fund investment reduces company-specific risk. This combination can be among the best investment options for Rs individuals looking to build up their long term wealth by having a portion of their portfolio in equities.
Table 1: XYZ Stock with Systematic Investment Plan Plan
Invest date Amount Price per share Shares purchased
Jan. 2000 Rs 1,250 Rs 56.72 22.04
Apr. 2000 Rs 1,250 Rs 54.19 23.07
Jul. 2000 Rs 1,250 Rs 31.34 39.27
Oct. 2000 Rs 1,250 Rs 22.60 53.31
Jan. 2001 Rs 1,250 Rs 22.10 56.50
Apr. 2001 Rs 1,250 Rs 19.05 65.62
Oct. 2001 Rs 1,250 Rs 18.13 68.95
Jan. 2002 Rs 1,250 Rs 16.14 77.45
Apr. 2002 Rs 1,250 Rs 14.58 85.73
Jul. 2002 Rs1,250 Rs 8.66 144.34
Oct. 2002 Rs1,250 Rs11.64 107.39
Total Rs15,000 Rs20.10 avg. 746.21 sharesowned.