SIP = [Experience + Discipline]

 SIP is a name that everyone is now quite in touch with. However, a sizable portion of our society is still ignorant of this well-known idea and how it works. So, today, we'll try to figure out this idea.

SIP 👉 Systematic Investment Plan.

What does "systematic investment plan" mean to you?

It is just a disciplined or well-planned approach of investing, as the name would imply.

But even with the preceding explanation, I don't think it is quite easily understood.

With the example below, we will attempt to decode it:

We'll use a very basic, everyday example next.

Let's imagine that we spent each month's some amount to buy 1 kilogram of rice through out the year. The average price of rice will therefore fall in-between the high and low prices, as seen by the graph below: 

Avg. Rice Price = [10+8+12+14+11+15+14+11+8+10+9+12] / 12 = 11.2

The average price Rs. 11.2 fall in-between Rs.15 [High] and Rs.8 [Low].

Now, if the price of the rice you bought at the average price of Rs. 11.2 rose to Rs. 15, and you sold all of the rice you bought at the new price Rs.15, you would make a profit of Rs. 46.5.

Profit = [Rs.15 - Rs.11.2] * 12 = Rs. 46.5

Now, we try to understand working funda of SIP.

The same idea now applies to the equity market, and if we continue to purchase mutual funds each month, then our average purchase price will fall in-between our high and low mutual fund price (NAV).

If we had a SIP of Rs 1000 per month for two years, we would have invested Rs 24000 and received 2224.6 units at an average cost of Rs 10.79.

After that, we will be able to sell this accumulated mutual fund at a greater price [NAV] in the future. 

After two years, the SIP will yield Rs. 31144.76, nearly a profit of Rs. 7144.75, when sold at current NAV Rs.14 [i.e NAV after 2 years]. 

We may continue to invest as well. Therefore, if the NAV rises in the future, we might profit more from the same investment. 

SIP combined with mutual funds has a twofold impact. SIP stands for systematic investment plan [Discipline], and a mutual fund is a collection of equities that is overseen on our behalf by knowledgeable fund managers [Experience]. 

So, experience and discipline complement one another.

The next article will go into further detail and attempt to shed light on SIP, how to work out for SIP, and the advantages of goal based SIP.

Disclaimer: This post is not considered a recommendation to buy, sell, or invest in any company; it is just intended for educational purposes. Do your research and due diligence before making an investment, and talk to your financial advisor.