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A BEGINNERS GUIDE TO MUTUAL FUNDS

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Mutual Funds - The Systematic Way
Investing regularly instils discipline. Systematic investment plans make this simple and easy for investors

Apart from straightforward investment and redemption in funds, there are some special ‘systematic’ ways of investing and redeeming your money in mutual funds. They are very useful in making you a more disciplined investor, as well as enhancing your returns.

Systematic Investment Plan (SIP)

SIPs are supposed to be a simple and straightforward idea. You invest a fixed sum regularly in a fund, regardless of market conditions. Over a long-term, you end up buying more units when the markets are down and fewer when the markets are up. Usually, your average price of acquisition is lower than what it would have been, had you tried to time the market by trying to predict and anticipate its movements. Instead of trying to time one’s investments, one should regularly invest a constant amount.

The arithmetic is simple. Suppose you are investing Rs.10,000.In a month when the NAV is Rs.20, you will get allotted 500 units because 10000/20 = 500. However, in a month when the NAV is Rs.16, you will get allotted 625 units, as 10000/16 = 625.

Thus you have automatically bought more units when the markets are lower. This is also called ‘Rupee Cost Averaging’. When the time comes to redeem your investments, all the units are worth the same. However, your profit margin is higher for units that were bought at a lower price. More the number of such units, higher would be the returns. One of the basic principles of investing is ‘Buy Low, Sell High’. SIPs automatically enforce this. However, Rupee Cost Averaging neither ensures you profits nor protects you from making a loss in declining markets.

To get the best out of your SIP, you need to keep it simple with an investment frequency that you can easily maintain and manage depending on your income. It is also important to invest for the long term and across market cycles. Here’s why.

Beyond the arithmetic of returns, there is another reason why SIPs make sense. They are a great way to override the normal psychological instinct to stop investing when the markets tank and prices fall. It is in this scenario that the real value of SIPs come into play. The normal tendency is to follow a herd mentality, i.e., invest more when prices are high and stop investing when prices fall. This is exactly the opposite of what most investment Gurus would follow. Thus SIPs force you to follow the right approach, much to your eventual benefit.

Systematic Withdrawal Plan (SWP)

SWPs are regular redemptions from a fund. There are a number of variations available in SWP. Investors can either redeem a fixed amount, a fixed number of units or all returns above a certain base level. Among other things, they are a convenient way to take out a regular income from a fund.

Systematic Transfer Plan (STP)

STP is a regular transfer from one fund to another belonging to the same fund house. It is like an SIP but the source of the money is from another fund. The most frequent use of an STP is when you have a lump sum to invest in an equity fund. For reasons listed above, it is always better to invest gradually through an SIP rather than with a large sum all at once. In such cases, you could put the lump sum in a liquid fund and simply give instructions to transfer a fixed amount into a chosen equity fund every month. Thus you earn steady returns from the liquid fund and benefit from ‘Rupee Cost Averaging’ followed by the SIP.

SUMMARY

Disciplined investing generally offers better returns as well as a number of other advantages. Mutual Funds offer different ways to manage such systematic and scheduled investing, most popular being Systematic Investment Plans or SIPs besides Systematic Withdrawal Plans or SWPs and Systematic Transfer Plans or STPs.

Next To Come: Mutual Funds - Complexity Vs Classification