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This is a simple strategy for accumulating wealth over a period of time by investing regularly at a fixed interval of time in mutual fund schemes, this is similar to the concept of recurring deposits scheme, but this being in equity come tagged with relatively a higher risk and higher return than the recurring deposit.
What is Systematic Investment Plan?
An investor commits to invest a specific amount for a continuous period at regular intervals, this ensures that he gets more units when prices are lower and fewer units when prices are high, this works on the principle of rupee cost averaging when invested at different levels and automatically participate in the swing of the market.
Advantages of Systematic Investment Plan:
Power of Compounding, To avail the benefit of power of compounding one has to start early and invest regularly, a delayed investment will lead to greater financial burden to meet the required goals, at early stage a less investment needed where as more investment is needed at a later stage to accumulate the same planned corpus.
It means averaging the cost price of your investments.
SIP helps in averaging the cost as equal amount is invested regularly every month at different NAVs. SIP works well in a volatile market as in the months where markets are down you get more number of units as the NAV is down and when the markets are up you get less number of units. But over all the prices gets averaged out.
Let us see how: Say you make your first investment of Rs 1,000 at a NAV of Rs 10. In this case, the units acquired will be 100 (1,000/10). You make the next investment of Rs 1,000 at a NAV of Rs 12. Units acquired now will be 83.33333 (1,000/12). Now also suppose that you make the third investment of Rs 1,000 at a NAV of Rs 9 and the units acquired will be 111.1111 (1,000/9).
The average purchase cost works out to Rs 10.19 (3,000/294.4444).