It is more famously known as SIP. It
is bit by bit systematic investment. Under this plan your investments are
staggered. That is you invest a fix sum either monthly or quarterly in a
mutual fund. Say, for example, you commit to invest a pre-specified amount
(Rs 500 onwards) every month or every quarter in a mutual fund. You fix a
date on which every month or every quarter the amount gets invested. The
first investment has to be by a cheque and then you can either give post
dated cheques (PDCs) or opt for electronic clearing system (ECS).
In ECS you give permission for the amount to be
directly deducted from your bank account on the fixed due date. The units
are allocated as per the then prevailing NAV on that day of the month. You
get more number of units if the NAV is low and vice versa if the NAV is
It means averaging
the cost price of your investments.
SIP helps in averaging the cost as an 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 units as the NAV is down, and when markets are up, you get less
units. But over all, the prices get 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
This concept, however, may not work in a rising
market. As the markets are constantly rising, you acquire less and less
units, and the average cost does not work in our favor. This is especially
true in the shorter period. But in the long-term scenario, the market is
volatile, the cost is averaged out, and the downside risk is protected.