This article emphasizes the fact that SIPs give superior returns compared to lump-sum investment. It also talks about various investing options available for SIPs (like Micro SIP), along with their characteristics and possible limitations. It advises you about the strategy to be followed for SIP investment.

(The article has been inspired by a question from the reader “rikinj”)

Why a Systematic Investment Plan (SIP) is better than a Lump-Sum investment

A question that is asked very often is: Don’t one-time, lump-sum investments give better returns than SIPs?

And the answer is, yes, most definitely.

Shocked? Well, don’t be. Because that "yes" comes with a big disclaimer: A lump sum investment can earn you the best return if it is timed right.

This means that it has to be timed right twice: For the purchase, and for the sale. If you are able to buy at the very bottom, and if you are able to sell at the very top of the price movement, you can make the best return.

The obvious question is: Can you time it right, twice, all the time?

The answer is: No. And the answer is "no" not just for small investors like you and me, but also for professional investors.

One can time the market maybe once or twice, but that would be just coincidence. There is no way anyone can consistently time the market. Because no one can know for sure if the bottom has been reached, or if the top has been achieved.

And therefore, although theoretically it is possible to earn superior returns by making one-time, lump-sum investments, practically, a systematic investment plan is the best available option.

Want to know why? Please read "Systematic Investment Plan (SIP) - A rupee a day, keeps worries away".

Now remember, analysis done by looking into the rear view mirror can draw different conclusions. Let me explain.

If you look at the historic data, and see the return given by a stock or a mutual fund (MF) scheme between its bottom and its top, it would always be more than the return given by an SIP in the same period.

(And that’s why I said that theoretically, it is possible to earn superior return by making one-time, lump-sum investments)

But the important point to remember is that when analyzing historic data, you know where the bottom and top were. But while buying or selling in real time, you don’t know how the price would shape up in the future.

And therefore, practically speaking, an SIP is the best option available for long term investors.

Options available for investing in a Systematic Investment Plan (SIP)

Ok, now that we are clear that SIP is the way to go, let’s understand the various options available for SIP investments.

I would broadly classify SIPs into two classes: Regular SIP, and Micro SIP.

Regular SIP: These are the traditional SIPs as we know them. Following are their characteristics:

• The investment minimum usually starts at Rs. 500, and there is no maximum
• The normal entry load is between 1.5% & 2.25%
• There is usually no exit load
• There is usually no lock-in period
• All investment options are open: Growth, Dividend and Dividend Reinvestment (Please read "Mutual Funds - Growth or Dividend option?" to know more about these options)
• All mutual fund (MF) houses offer this SIP option

Micro SIP: These are the new breed of SIPs, which cater specifically to people who want to divert their savings, very small in amount, into mutual funds (and therefore into the stock markets). Following are their characteristics:

• The investment minimum can be as low as Rs. 50
• The normal entry load is between 1.5% & 2.25%
• There is usually a lock-in period, ranging from 3 to 5 years. This means you have to continue investing every month for this period.
• There usually is a more-than-average exit load (say 3% to 4%)
• Usually, only Growth option is available
• Companies like Reliance Mutual Fund (Reliance AMC) and ICICI Mutual Fund (ICICI Prudential AMC) have pioneered it, although most other fund houses are expected to follow

Ok, so we see that there are many limitations for a micro SIP. But are they necessarily bad?

In my opinion, they aren’t – because most of the limitations just make you invest in the MF scheme for the long term. And that’s how investments in equity mutual funds should be! (To know more, please read "Stocks - The winning bet for the long term")

It is no different from a recurring deposit in a bank, which forces you to make small, monthly payments for a pre-determined period of time, and which has a penalty for withdrawing before time.

The only difference is that the micro SIP would give returns that can far surpass returns given by a recurring deposit!

(Continue to Page 2 to know "How to invest in a Systematic Investment Plan (SIP)")

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Note: Please treat the opinion expressed here as a broad suggestion. Please consult your financial planner / investment advisor before making any investment decision.