Benjamin Graham, the father of value investing, has termed dollar cost averaging as one of the top 3 tenets of investments for a defensive investor. Dollar cost averaging is nothing but the systematic investment plan.
Systematic investment plan is a scheme that allows investors to invest in a mutual fund a certain amount of money for over a period of time.
For example, investors can invest `5,000 in a mutual fund every month.
Advantage of SIP
Systematic investment plan has many advantages over one time investment. Some of the advantages are mentioned below.
Price averaging: SIP allows you to average the price over long period so that the impact of changing prices of mutual fund is minimised.
You can buy more units when the prices drop and buy less when the prices move up. The advantage is that you do not have to worry about price movement.
Discipline: SIP instills in you a sense of discipline towards investment and savings.
Low base requirement: You can start SIP with a much lower investment. Many banks and financial institutions allow investment via SIP as low as `500 a month.
Look at the column total investment and investment at current price. You can see that total investment in the case of SIP is almost always lesser than the investment needed to buy the same accumulated quantity at current price.
This may not be true when the prices keep going down continuously. We know that prices of mutual fund or stock do not go up or down straight.
The short term ups and downs usually happen one after the other. SIP moderates the impact of these short term ups and downs of the mutual fund prices.
You can ask your bank to allow a mutual fund of your choice debit a certain amount towards investment every month. You have to specify the amount, date of the month when money will be invested, and duration of SIP. For example, if you choose to invest `3,000, 10th of every month, for 3 years, the mutual fund will keep debiting `3,000 from your account towards investment in the fund for 36 months. You can also follow this on your own by investing `3,000 every month. However you need to be very disciplined with your budget to achieve this.
Variants of SIP: Daily, Monthly
Daily SIP scheme requires investors to invest daily while monthly SIP allows investors to invest monthly.
At first glance, daily SIP seems to take care of volatility better than monthly SIP, but there is no empirical evidence that has shown significant difference in returns.
Key aspects
* Daily SIP is not allowed by many mutual funds and hence your options are limited. Monthly SIP options are available in almost all mutual funds.
* The most important aspect is to do with our habits. We are used to planning for a month.
It is more convenient for us to see income, investment, and expenses in a monthly timeframe and hence we can plan better towards a monthly SIP.
* The final aspect is calculation of taxes.
Daily SIP makes tax calculation more complex as you have to evaluate the capital gain by comparing the selling price with everyday price for the last 1 year.
(The writer is CEO of bankbazaar.com)