SIP works!

Thanks to the media most people know about SIP – Systematic Investment Planning. Of course the basis of SIP is rupee cost averaging (or dollar cost averaging as an international website would call it). Rupee cost averaging is a series of equal rupee investments made at regular intervals. It sounds simple to do so most people are skeptical, however it can also be used as one of the most powerful ways to build wealth.

I know a security guard who took money from his salary and invests it – through rupee cost averaging. I have not seen him skip a single payment for the past 5 years in a good fund. He has increased the amount twice and has not even murmured during this drop from 21000 to 8000.

Rupee cost averaging is a simple to understand, straightforward strategy that can be used by anyone from investment experts to novices. Instead of investing a lump sum all at once, you invest equal amounts at regular intervals over a period of time. However I am convinced it requires a complex mind to understand a simple thing. I know of one CEO who has been doing SIP for the past 12 years in the same fund without skipping one payment!

But there’s more to this strategy …

It’s What the Experts Do

Rupee cost averaging is used by large investors who have portfolios already, or individuals who invest with small, consistent amounts. In short, everyone can use this timeless strategy. Just like compounding – instead of second guessing doing a SIP is more important.

For many large investors SIP works in shares that they pick – providing them anonymity. However for a small investor without adequate research SIP will NOT WORK in a single scrip. It will work only in a big well constructed portfolio.

Many funds make many smaller purchases when building up a large position in a scrip.

For investors who may not have the time, energy or knowledge to time their transactions, this strategy can lower your average cost per share by spreading out their purchases.

Lower Your Purchase Prices

For example, let’s use a smaller investment amount to illustrate -Rs.50,000. If you invested Rs.50,000 into an index with a Rs.50 net asset value (NAV) at the beginning of the year, you’ve purchased 1000 shares.

But let’s say you spread those purchases out in Rs.4170 monthly payments. And let’s say that index has been fluctuating over the course of the year with a range of Rs.41 to Rs.57.


Here’s how it looks…

Beginning of Month

Rupee Investment

NAV

Units Purchased

1

Rs.       4170

Rs.    50

83.3

2

Rs.       4170

Rs.    44

94.7

3

Rs.       4170

Rs.    41

101.6

4

Rs.       4170

Rs.    41

101.6

5

Rs.       4170

Rs.    44

94.7

6

Rs.       4170

Rs.    50

83.3

7

Rs.       4170

Rs.    56

74.4

8

Rs.       4170

Rs.    50

83.3

9

Rs.       4170

Rs.    41

101.6

10

Rs.       4170

Rs.    50

83.3

11

Rs.       4170

Rs.    56

74.4

12

Rs.       4170

Rs.    57

73.1

Total

Rs.     50,000

1049.5

Because of the choppiness of the share price, your rupee cost averaging strategy allowed you to purchase more shares during the same period with the same investment amount. Imagine if you could increase all your investments by 4.9%…

Rupee cost averaging reduces the risk of buying your investment at its highest point. By making multiple purchases, you’re bringing your average cost per share down.

In addition to simply being a way to lower you costs, it’s practical as well. Very few of us start out the year with the full amount of funds we have to invest over that year.

Start with a consistent amount (most of them allow transactions as small as Rs.500) and set up a regular investment schedule. For newer investors, it’s one of the easiest and best ways to build great wealth.

For more experienced investors looking to get back into the market, it’s the perfect way to rebuild or start new positions without a confirmation that we’ve hit a bottom or not.

It should be a lesson for the millions of people who believe they can’t get started investing until they have a large amount saved up. You can start small, you can start smart – and you can come out on top.

The Other Side to Rupee Cost Averaging

There are some limitations to rupee cost averaging. As a strategy, rupee cost averaging works best in mixed, uneven or choppy markets.

If you were going into a sharp downturn, the best strategy would be to wait as long as possible before getting back in – like we did from 21k to 8k. On the other hand, if the market was going to move straight up, you would want to put all of your money in as quickly as possible.

But the fact of the matter is that no one knows (except those market experts who appear on television) what the markets will do tomorrow, next week, next, month or any period of time in the future. So as intelligent investors, we need to choose a strategy that will allow us to maximize our returns – regardless of the Street’s direction. However the media will do stories from time to time saying how one time buying was better than SIP and how one time selling at 21k would have been better! Unfortunately these stories come far after the market has gone down (or up) so less intelligent people cannot use this wisdom.

It’s why rupee cost averaging is so flexible and appropriate for the market conditions right now.

It can be done on any timeline. Some investors cost average for a day, others for a year. You choose the timeline that’s most appropriate for your needs. The net result is that your average cost should equal the average price during that period.

And lower costs mean higher profits. It all starts with education. Many people do not appreciate the cost of financial education.

If you think financial education is expensive, try financial illiteracy.

Related Articles:

Post Footer automatically generated by Add Post Footer Plugin for wordpress.

Leave a Reply

This blog is kept spam free by WP-SpamFree.