How does an SIP work?
By now, you may have a fair idea of what an SIP does. And you are seriously considering starting one. But you may have doubts about how it really works? Let us put your doubts to rest! There are two distinct advantages to an SIP.
Assume that you want to upgrade your wardrobe. You decide on the number of garments you want to buy and the potential brands from whom you want to. One of the brands has a sale. Wouldn’t you prefer to buy from that store knowing that you will get more in the same budget that you may set aside? Now, if there wasn’t a sale. You would still go and buy from the shortlisted brands as planned but you will not be able to/want to buy more.
An SIP works in a similar fashion. Supposing you invest INR 500 every month. In a given month, if the Net Asset Value (NAV) of your fund is INR 50 per unit, you will be able to accumulate only 5 units. In another month, if the NAV goes down to INR 10 per unit, you will be able to gather 50 units for the same price. If you were to calculate the average price per unit, it would be close to INR 19 per unit. This concept is called rupee cost averaging.
It is important to remember here that rupee cost averaging is not a guaranteed way to make more money or eliminate risks. By staying invested irrespective of market conditions, one is able to consistently grow capital over the long-term.
All of us remember magic shows. We would watch in awe as the magician pulled something out of thin air! Pulled out two objects from the hat when he had only put in one! What if we were to tell you that SIP works in a similar fashion? Only in this case, the magic lies in starting early and staying
consistent. Then watch in awe as your money grows through the magic of compounding!
Don’t believe in magic? Here is an example. Assume you are investing INR 1500 each month through an SIP. At the end of year one, if the rate of interest remains more or less consistent at 10 % pa, you will have made INR 19,800. If you stay invested, in the second year, you will have made close to INR 42,000*. In the fifth year, you will have made close to INR 1,18,000 with an investment of just INR 90,000! Now just imagine how much wealth you will be able to accumulate if you continue putting money in an SIP till you retire! Is it anything lesser than magic?