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Mutual Funds and SIPs are the latest trends in investments. So why is everybody talking about this? Let us look a little closely at how these work.
I am an amateur investor in mutual funds and this article is my attempt in explaining to you in layman terms about the benefits of SIP.
When you invest in Mutual Funds, you buy them as units. Just like you buy 10gms of gold or a dozen apples, you can buy X units of a mutual fund.
Just as the cost of 1gm of gold could be Rs.2700 or an apple could cost Rs.32, the price of every unit of a mutual fund is called NAV (Net Asset Value). This NAV changes every day depending on the market conditions. So for every investment, you would get X units depending on that day’s NAV. Similarly, when you redeem (that is close X no. of units in that fund or the entire fund), your units will be multiplied by that day’s NAV.
For example, when you invest Rs.10000 in a fund and that fund’s NAV that day is Rs.40, then you get 250 units (ie. 10000/40) of that fund. Then you invest another Rs.10000 in the same fund on another day when NAV is Rs.50. So you would get 200 units (ie. 10000/50) of that fund. So now you have a total of 450 units.
Now if you redeem the entire investment some months later and the NAV that day is Rs.100, then you will get 450100 = Rs. 45000 (profit!). Or if NAV is Rs. 10, you will get 45010 = Rs.4500 (oops, bad time to redeem!).
Generally speaking, there are two ways you can invest in mutual funds – lump sum or SIP.
Lump sum investment is nothing but investing a bulk amount on any day that you wish. There is no consistency here unless you personally enforce it.
SIP is Systematic Investment Plan. It is a fixed amount that you compulsorily invest at a fixed frequency in mutual funds – generally, every month on a date(s) that you choose when applying for the fund. So if you choose to invest Rs.2000 on the 15th of every month in a scheme, then your linked bank account will be automatically debited for that amount every month, on the date you chose. Or you could give a bunch of post-dated cheques while applying for the fund.
There are a few reasons why SIP is strongly advised.
Your account will be auto-debited every month unless you canceled your SIP altogether. This will help you in following the more beneficial (Expense = Income – Savings) formula rather than saving only what is left after your monthly expenses.
Every other investment like FDs, RDs and bank deposits have very poor returns post-tax. While SIPs in mutual funds not only have very good returns, they also give you the enormous benefit of multiplying your investment using the power of compounding.
Not all of us are Warren Buffet. If we understood market trends or had the time for it, we would be in Goldman Sachs or JP Morgan. You cannot keep track of the market regularly. SIPs help you invest money consistently and let you catch both the highs and lows of the market. This, when left undisturbed for a long time, averages out to multiply your earnings by many folds.
What you see is above is an illustrated example of investments in mutual funds. While a couple of entries are lump sum investments, the remaining are SIPs.
What I have done is – I have chosen a real mutual fund with its real NAV values during the last 1 year. What I have assumed is the invested amount. As you can see, the lump sum investments are erratic as they depend on availability of funds whereas SIPs are regular. This fund’s NAV gradually increases until it sees a dip in November and December of 2016. But again it catches up to go higher. Over the course of this one year, investments in this mutual fund alone have seen a return of 26.91%!
That is the power of investing systematically.
Published here earlier.
Image source: pixabay
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