Systematic Investment Plan: Introduction to Smart Investing

Systematic Investment Plan: Introduction to Smart Investing

There are various methods that can help make your investment journey much easier. One of the most popular methods is the systematic investment plan.

This method can assist you in investing and help you make more consistent investments. In this article, you’ll learn more about what a systematic investment plan is, as well as its pros and cons.

Folder with name SIP over keyboard keys

What is Systematic Investment Plan

A systematic investment plan is also commonly referred to as SIP. It’s a plan that allows investors to make regular equal payments into mutual funds, trading accounts, or retirement accounts. You can setup the plan to track your payments to your 401(k) and regularly save without taking any additional actions.

Aside from these, you can also benefit from the long-term advantages of dollar-cost averaging (DCA). Dollar-cost averaging involves buying a fixed-dollar amount of a security no matter what the price might be.

Keep in mind that shares can be bought at varying prices. This then means that the average cost per share of a security has the potential to decrease over time. Additionally, the risk of investing a large amount of money also decreases.

Most often, liquid accounts such as money market accounts are used for funding payments. They can also be used for buying shares that go into a systematic investment plan. Additionally, most investors decide to reinvest dividends received from their holdings back into purchasing more stocks. Such actions are referred to as DRIPs or Dividend Reinvestment Plans.

Systematic Investment Plan in relation to Dollar-Cost Averaging

Dollar-cost averaging is an investment strategy that implements the regular and periodic purchasing investment shares. It helps reduce the total cost per share of an investment.

The relationship between the two lies in the fact that systematic investing is the very foundation of dollar-cost averaging.

When implementing dollar-cost averaging strategies you will usually be employing automatic purchasing schedules. There are times greed, fear, complacency, and other negative emotions may cloud your judgment regarding investment selection and asset allocation. These strategies aim to keep investors – like you – from making poor decisions based on emotional reactions to the market’s fluctuations.

This is mostly best used by long term investors. Principles such as buying high and selling low is in direct contrast with dollar-cost averaging and other wise investment practices.

Let’s say that stock prices soar and news sources report new records on stock indices and potential profits. The initial reactions that investors will have are to buy more risky assets. Likewise, if the stock prices drop dramatically for an extended period of time, many investors decide to sell their shares.

Systematic Investment Plan in relation to Dividend Reinvestment Plans

With dividend reinvestment plans, shareholders will be able to invest variable amounts in a company over a long-term investment. When you reinvest dividends, you’ll be able to purchase shares or fractions of shares in publicly traded companies. But with this, instead of receiving a quarterly check for dividends, the company, agent, or firm will use the money to buy additional shares of the company under your name.

No broker is required when facilitating the trade. Because of this, company-operated dividend reinvestment plans are commission-free. DRIPs are flexible in nature. These means that you may choose to invest large or small amounts of money depending on your financial situation.

There are some DRIPs that offer optional cash purchases of additional shares directly from the company. Most of the time, these offers are at a 1 to 10% discount with no fees.

FSMSmart - printed words of various investment instruments caught in mouse trap

Systematic Investment Plan in Mutual Funds

There are two ways you can choose from when it comes to investing in mutual funds. One is outright payment directly to the mutual fund. The other one is the periodic payments to a predefined mutual fund scheme.

The first type is referred to as a Lump Sum investment and the second one is the systematic investment plan.

A systematic investment plan is considered to be a flexible and easy investment plan. Your money is automatically debited from your bank account and invested into a certain mutual fund scheme. You’re given a specific number of units based on the net asset value for the day.

In order to actually get started, you first have to choose the mutual fund scheme, investment amount, and time period. As was previously mentioned, you can choose to invest a small sum at the beginning. You can then decide to steadily increase for more accumulated wealth if you want.

Investments are typically made on a daily, weekly, monthly, or quarterly basis on a fixed date. Two of the most popular SIPs in mutual funds are the monthly and quarterly SIPs. However, the daily SIP in mutual funds is gradually gaining popularity.

Pros and Cons of Systematic Investment Plan

systematic investment plan infographic

Pros of Systematic Investment Plan

  • Not too stressful

When you take the route of systematic investment plan, you no longer have to worry about finding the right time for the market. You could rest assured that your plan will be able to take care of the right moment to enter and exit the market.

SIPs are normally done at regular intervals over a long period of time. This tends to beat the market volatility and the risks are easier to moderate. Moreover, during market highs, more units are bought, and the opposite happens when the market is experiencing lows.

The mechanism is already set and a fixed amount is being deducted from your account every month. Despite this, you should still consider managing and reviewing the market on a periodic basis.

  • Compounding power

One of the most recognized basic rules of investing is that you should start early. Investors who start early will be able to build the same amount with lower investments as compared to someone who starts later.

Systematic investment plans don’t require huge amounts of capital. With this in mind, you can start investing with a low sum each month. You can then invest much early in life and take advantage of the ‘Power of Compounding.’

  • Convenience

Investors consider pooling large amount s of money is not economically feasible. Therefore, it’s considerably more convenient to contribute small amounts of money in a regular basis.

Additionally, you can easily time your investments based on your income flow.  You can manage, set-up and monitor SIPs. There are low investment amounts as well as various available payment intervals that you can base on. Once the initial formalities are over, the consecutive payments will be directly deducted from the bank in the specified date. You no longer need to trouble yourself with manual investment.

  • Have better discipline

Most of the investments in SIP are conducted in the form of weekly, fortnightly, monthly or quarterly installments. Systematic investment plans encourage investors to instill the habit of saving before investing. SIPs give you the opportunity to invest in monthly schemes. These conditions are considered to be far easier to maintain in the long run.

Stock market chart

Cons of Systematic Investment Plan

  • Aimless on its own

When using a systematic investment plan, you should simply add it as a part of your investment plan. Your goal should also be clear. Without having an objective, SIP might not be of much use.

  • It can end up being used in wrong funds

Using a systematic investment plan in the wrong funds would not improve investment prospects. Having a poorly managed fund will not have a different outcome not matter the mode of investment. Therefore, you must first find a well-managed fund.

  • Rising markets can affect your expenses

The amount you invest when using a systematic investment plan is a fixed amount no matter if the market experience highs or lows. There are cases when SIP could prove to be more expensive than lump sum payments. This is mostly seen during market lows.

Additionally, you wouldn’t be able to immediately change the amount being invested in relation to the market fluctuations. This can keep you from taking advantage of the upswings. Hence the recommendation that SIPs should be run for more than a year.

  • Not suited for irregular income flow

Using a systematic investment plan is not advisable for people who have irregular income flow. This is mostly due to the fact that the investment is meant to be made at predetermined intervals. It also means that failing to maintain adequate balance in the bank of the day of debit of SIP will return dishonored. This means that the investment will not take place that month.

Conclusion

Weigh the pros and cons carefully before making up your mind. Using a systematic investment plan can definitely make your investment journey easier. But just like with everything else, there are also some downsides that you must not disregard.

If you feel like the benefits outweigh the possible losses, then using an SIP might be the method you’re looking for. Just do your research and make sure you understand it as much as you can. With enough practice and research, you’ll soon be able to master the systematic investment plan.

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