HARNESS THE POWER OF COMPOUNDING AND RUPEE COST AVERAGING USING SIP
SIP is an option designed by mutual funds, allowing you to invest a small sum in the stock market on a regular basis. The main advantage of a SIP is that it averages out your cost in the long run as an investor gets more units when the markets are down.
The periodicity of a SIP can be determined by one’s cash flow and can be increased with a rise in income or addition of financial goals. In brief, a SIP helps you grow even a small investment into a large corpus, thanks to the power of compounding. The trick is to start early.
SIP is better as it averages out the purchase cost rather than lock up the money at a particular NAV as in lump sum investments.
Advantages of SIP:
Power of Compounding
“Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.” – Albert Einstein.
To avail the benefit of power of compounding one has to start early and invest regularly. At an early stage, a less investment is needed and your money gets more time to grow whereas more investment is needed at a later stage to accumulate the same planned corpus.
The concept of compounding is simple. Power of compounding is nothing but interest earned on interest or profits earned on profits. The power of compounding over a long horizon, if invested in the right asset, is enormous. From a wealth creation stand point, time is the most important factor in investing, much more important than factors like market levels, valuations (PE ratios), current economic and political scenarios etc. Example
If you invested Rs. 1,000/- in an instrument giving 10% return in a year. At the end of year 1, value will go to Rs. 1,100 and in year 2 you will earn return on Rs. 1,100 and not on original investment of Rs. 1,000/-.
Rupee Cost Averaging:
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. When markets are down you get more number of units and when the markets are up you get less number of units. Hence, over all the prices gets averaged out.
Rs 5 Lakhs invested for 5 years at an annualized return of 12% will yield a corpus of Rs 3.8 Lakhs. The same money spread over 20 years at a monthly instalment of just Rs 2,080 will yield a corpus of Rs 24 Lakhs. You do not need a sufficiently large investible corpus to create wealth, investing from your regular monthly savings, even if it is a small amount can help you create substantial wealth. This is the essence of systematic investments. The power of systematic investment is unlocked through compounding and the key to its success is discipline. Mutual fund Systematic Investment Plans or SIPs is a proven way to create long term wealth from your regular monthly savings.
SOME MYTHS RELATED TO MUTUAL FUND INVESTING VIA SIP
Myth-SIP works only for Equity funds because it takes advantage of volatility through Rupee Cost Averaging.
Fact- Remember the essence of SIP is the power of compounding; rupee cost averaging is an auxiliary benefit. SIP advantage works same for Debt Funds also. Debt as an asset class also brings volatility which can be enjoyed by you using SIP rupee cost averaging.
As Per Asset Allocation and Risk apetite even Debt can be advised for Long Term. SIP in Debt Funds works really good for long term using the same advantages of SIP. Indians by nature traditionally have used RD as Systematic Tool under Fixed Income Bucket.
Myth –Do not Invest when the markets are low, it will cause a Loss
Fact – Invest when markets are down and get more units at a discounted NAV
Many People believe in this myth and it still prevails today. But the fact is, when the market is down ,you get more units at a discounted value .This extra units will be useful when the market goes up again .this is known as rupee cost averaging, SIP provides this benefits, it buys more units when markets are down, buys less units when markets are up.
EXAMPLES OF POWER OF COMPOUNDING
If You invest Rs 8000 in a fund with an assumed rate of return from the fund 12%
From the above table , we can see that the opening balance principal + interest on that return gets calculated and so on. It is something like 1 becomes 2 becomes 4 become 8 and so on ….
As we said it is the Time spent in the market creates enormous wealth rather Timing the market not an right option. You can check Fund Value growth rate after 5/10/15/20 years.
|Month||Opening Balance (Rs.)||SIP amount (Rs.)||Assumed Return@ 12% p.a.(1% p.m)|
|(Opening Balance+ Return)*Returns
Develop the habit of financial discipline using – Goal Based SIP Investing
Many Financial Planners Have coined the term – Target Investment Plan .Target Amount – Amount required for the Goal. Period-Time In Hand to achieve that goal, thereby calculating SIP Amount required p.m to get the required amount post completion of Time Period. Contact Your advisor who can assist you in telling you the Near to correct SIP amount investment required for your Financial Goals
Financial discipline is rarely something anyone is born with neither It is taught in school as any subject. We have to work on it.
Let us take the example of goal-based investing. A newbie investor may start a small SIP to invest a certain amount over 5 years to achieve a goal. However, after 18 months, this individual may be tempted to buy a new laptop and would be falling short of some amount. If this individual decides to redeem the corpus which has been created so far, he may not only lose the opportunity of creating more wealth but would also fall back on his efforts to achieve his goal. Therefore it is critical to adhere to financial discipline when it comes to investing. Starting small makes it easier to get used to this. It is worth creating a habit of putting aside a small amount.
BENEFITS OF STARTING THE SIP INVESTMENT EARLY
|Name of the Person||Start Age||Retirement||No. of years invested||Amount invested per month||Total amount invested(Rs.)||12%p.a.||15%p.a.|
Investor X started at age 25. His corpus at age 60 @15% p.a. is Rs. 7.43 crores approx.
Investor Y started at age 30. His corpus at age 60 @15% p.a. is lower at Rs. 3.5 crores approx.
Investor Z started at age 35. His corpus at age 60 @15% p.a. is much lower at Rs. 1.64 crores approx.
5 BASIC POINTS TO KEEP IN MIND AS KEY LEARNINGS
Start Now: You can see the cost of delay, in a mere 5 years between X and Y.
Invest long-term: Power of compounding is the 8th wonder of the world (Einstein)-The longer you invest, the more you accumulate. X invested the longest time, resulting in the biggest corpus.
Invest regularly and remain invested: Discipline is key when it comes to saving. All 3 invested Rs. 5000 every month.
Don’t be affected panicked by market volatilities: SIP’s will help average out the cost of your investments. (Rupee Cost Averaging)
Easy on the pocket: You don’t need a lumpsum -a small amount every month counts a long way.