Convenience is the middle name
of mutual funds – one may not be exaggerating by saying this. The convenience
that mutual funds provide, has been highlighted in many discussions. This
ensures that mutual funds become an integral part of any individual’s personal
Let us look at the various
conveniences. The first and foremost is the combination of very high
transparency and easy liquidity – we had written about this in one of our
Another feature of mutual fund
as a product is the unitisation of the investment. The money invested into a
fund is converted into small units of the fund. In fact, an investor can also
hold fractions of the unit. This allows an investor to invest (or withdraw) any
amount of money – large or small (subject to a small minimum limit) depending
on one’s needs. This facility makes investing in a mutual fund similar to
operating a bank account.
Over the years, as the product
has matured, the investment advisors have packaged some of these features and
devised some excellent investment strategies. These packages then help an
investor match the cash flow with the investment account. Let us look at one
such strategy: systematic investment plan (SIP).
Systematic investing is a
simple form of investing on a regular basis. For most investors the regular
cash flows are on a monthly basis – be it salary or various household expenses.
In that case, the net cash flow, or the difference between income and expenses,
or the savings also happen on a monthly basis. Hence, there is a clear need to
have a solution to park this monthly saving somewhere. This is where mutual
funds offer a systematic investment plan. An investor has to fill up one form
and submit the same with multiple payment instruments (or instruction to one’s
bank for multiple investments). Then the mutual fund company takes over the
entire administrative part of the process, i.e. handling the payment
instruments, custody of the same, deposition in bank, sending information of
transaction to the investor, etc. The investor has to only ensure sufficient
balance in the bank account. While an SIP can be done in any mutual fund, it
offers certain distinct advantages when done in an equity fund.
Equity as an asset class has
two characteristics: one, in short periods of time, the prices of equity
products fluctuate a lot; and two, over long periods of time, equity has the
potential to create wealth by giving excess returns over inflation and taxes.
SIP takes the advantage of both these characteristics of equity and works on
two principles: the power of compounding and rupee cost averaging.
When one invests a fixed sum
every month, one is able to turn the volatility of stock markets to one’s
advantage. Let us see how it works. An investor is able to save a sum of Rs.
3,000 every month and decides to enter into a systematic investment plan in an
equity fund (let us assume there are no loads – we will discuss about loads
later). As equity prices fluctuate, the NAV of the units of the equity fund
will also fluctuate. However, since the number of units purchased would be
inversely proportional to the NAV (or the price of purchase), every time the
NAV is high, the investor would buy fewer units and when the NAV is low, the
investor would buy more units. This will lower the average cost of buying the
Thus, systematic investing
offers a direct benefit of matching an investor’s requirement of managing
monthly savings while also provides additional benefits of the power of
compounding and rupee cost averaging. In this way, SIP works best to help an
investor create wealth.
Many also do an SIP in liquid
funds, which allows one to accumulate money in a slow and steady manner to
build a reserve fund. While this does not offer the benefit of “Rupee cost
averaging” discussed earlier, it serves a definite purpose of accumulation by saving
small amounts regularly.
The author runs
Karmayog Knowledge Academy. The views expressed are his personal opinions.