A systematic investment plan (SIP) is a simplified way to invest in mutual funds. A predetermined amount is automatically debited from your bank account and invested into the mutual fund of your choice. The automatic processing of the system makes it easy and simple for busy individuals to save for retirement.
Because the investments happen systematically, SIPs also have the advantage of dollar cost averaging. Dollar cost averaging is the natural advantage of investing an equal amount into an investment over time, regardless of price fluctuations. When asset prices are down, the equal amount invested means a greater amount of the asset can be purchased than when prices move higher. For long-term investors, this strategy reduces the risk of timing the market and allows them to ease into large positions with low average prices, especially during volatile periods.
Simple Setup: Investors know exactly how much they will be investing each month and where it is going. This is useful for long-term investors who don’t want to worry about day-to-day fluctuations in their portfolio.
Disciplined Long-Term Savings: Let’s face it, saving for the long-term is difficult. An SIP reduces the day-to-day decision making that usually hurts long-term savings plans. This way, investors save for the long-term without the hassle.
Long-Term Gains: Capital gains taxes can cripple your investment returns. Luckily, with SIPs the long-term perspective allows investors to be taxed at long-term capital gains rates instead of short-term. For a single male earning between $39,000 and $89,000, for example, short-term capital gains are 25% of investment income, while long-term capital gains are only 15%.
Major Points to Consider
The Mutual Fund Strategy and Risk Exposure: Systematic long-term investments in mutual funds are slightly different than normal stock buying or selling, but do they have many things in common. As with a strong company, a good mutual fund has a stable and repeatable way to consistently create profits for its investors. For a long-term SIP investor, mutual funds with diversification across global markets and asset classes will be the safest investment. Not even the experts can predict the long-term trajectories of asset classes, so it is safer to diversify into all of them. While you might not have the “next hot sector”, you will be able to sleep soundly at night knowing you’re not 100% exposed to the next bubble.
Stability Regardless of Leadership: Like CEOs, mutual fund managers come and go. For an SIP investor a mutual fund with strong performance, regardless of management change, is essential. Managers may have strategies that perform brilliantly in one market environment but that cannot be adapted when the market environment changes. By not relying upon the genius of one man, but rather relying upon the strength of a system, the SIP investor can smooth out investment performance and ensure long-term gains are there when needed.
Asset Turnover and Consistency of Performance: SIP investors should focus on stable and consistent performance across long periods of time. The mutual funds should not have high turnover rates because this metric implies that the fund managers are more focused on short-term trades rather than long-term investments. Further, high turnover rates can suggest that the fund managers are missing out on a large number of investments, trading out of them before they have to be reported to their investors. Both of these options are negatives for SIP investors.
The Bottom Line
SIPs are best suited for investors with stable flows of capital coming in who do not want to worry about their day-to-day savings plan. SIP investments excel over the long-term because they capture the power of dollar cost averaging, long-term capital gains taxes and compound interest, and allow investors to avoid costly asset bubbles through long-term global diversification. SIPs are a smart way for individuals with long-term time horizons to make stable contributions to their retirement account while leaving the hows and whys to investment experts.
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