By investing in a SIP, an investor automatically imbibes some very fundamental principles of sound investments such as:
- Rupee Cost Averaging
What is Compounding?
The power of compounding, simply put, is making your money work for you, from a very early age.
Mr. A starts investing a sum of Rs.10,000 per month at the age of 35 years, towards his retirement occurring at the age of 60 years. The rate of interest is assumed at a conservative 8% compounding. His retirement kitty at the end of 25 years at the age of 60 will work out to Rs 95,10,264.
On the other hand, Mr. B starts investing the same amount of Rs 15,000 at the age of 40 i.e. five years later, at the same rate of interest; with a plan to retire at the age of 60. His retirement kitty at the end of 20 years at the age of 60 will work out to Rs 88,35,306.
It can be seen that by starting the investment only five years earlier, Mr. A has earned more than Mr. B by a margin of Rs 6.75 lakh even though Mr B is contributing Rs 5,000 more than Mr A (actually 50% more) for the entire period of 20 years.
From the above example it can be observed that, compounding shows its impact more prominently over longer tenures of time.
Rupee Cost Averaging Concept
The Mutual Funds schemes are priced at Rs 10 p.u. in the initial stage. Thereafter depending upon the market conditions, its Net Asset Value is declared daily at the end of the day. In growing markets the NAV soars whereas in market downturn the NAV goes down .
Since nobody can predict the market, you diligently invest a fixed amount at periodic intervals and you are allotted varying number of units at every interval. Higher the NAV, lower the units and vice versa.
As a result your average cost p.u .gets adjusted accordingly. In other words, you buy more units when the market is low and less, when it is high and that too automatically and systematically on a given date.
SIPs help to average the cost of purchase over a period of time and the concept works particularly well in a volatile market, since, when the markets are down, you get higher number of units.
Rupee Cost Averaging (RCA) is an automatic mechanism in SIPs, which eliminates the need to time investments. When RCA is at play, investors need not worry about where share prices or interest rates are headed. In order to bring in the effect of RCA, all one needs to do is to invest fixed amounts at regular intervals.
Let’s look at the SIP returns given by three funds at a small commitment every month.
10 year SIP returns*
Value of Rs 5000 invested every month (for 10 years)
*Returns are compounded annualised.
Note: These are actual returns given by existing schemes of three different fund houses. However, the fund names are not revealed so as to not influence investor decisions. The important point we want to bring out is that SIP will work its magic in majority of the schemes.