What Is a Systematic Investment Plan (SIP)?
A systematic investment plan (SIP) is a plan in which investors make regular, equal payments into a mutual fund, trading account, or retirement account such as a 401(k). SIPs allow investors to save regularly with a smaller amount of money while benefiting from the long-term advantages of dollar-cost averaging (DCA). By using a DCA strategy, an investor buys an investment using periodic equal transfers of funds to build wealth or a portfolio over time slowly.
Key Takeaways
- A systematic investment plan involves investing a consistent sum of money regularly, and usually into the same security.
- A SIP generally pulls automatic withdrawals from the funding account and may require extended commitments from the investor.
- SIPs operate on the principle of dollar-cost averaging.
- Mostbrokerages and mutual fund companies offer SIPs.
How Systematic Investment Plans (SIPs) Work
Mutual funds and other investment companies offer investors a variety of investment options, including systematic investment plans. SIPs give investors a chance to invest small sums of money over a longer period of time rather than having to make large lump sums all at once. Most SIPs require payments into the plans on a consistent basis—whether that's weekly, monthly, or quarterly.
The principle of systematic investing is simple. It works on regular and periodic purchases of shares or units of securities of a fund or other investment. Dollar-cost averaging involves buying the same fixed-dollar amount of a security regardless of its price at each periodic interval.
SIPs allow investors to use smaller amounts of money with the benefits of dollar-cost averaging.
As a result, shares are bought at various prices and in varying amounts—though some plans may let you designate a fixed number of shares to buy. Because the amount invested is generally fixed and doesn't depend on unit or share prices, an investor ends up buying fewer shares when unit prices rise and more shares when prices drop.
SIPs tend to be passive investments because once you put money in, you continue to invest in them regardless of how they perform. That's why it's important to keep an eye on how much wealth you accumulate in your SIP.
Once you've hit a certain amount or get to a point near your retirement, you may want to reconsider your investment plans. Moving to a strategy or investment that's actively managed may allow you to grow your money even more. But it's always a good idea to speak to a financial advisor or expert to determine the best situation for you.
Special Considerations
DCA advocates argue that with this approach, the average cost per share of the security decreases over time. Of course, the strategy can backfire if you have a stock whose price rises steadily and dramatically.
That means investing over time costs you more than if you bought all at once at the outset. Overall, DCA usually reduces the cost of an investment. The risk of investing a large amount of money into security also lessens.
Because most DCA strategies are established on an automatic purchasing schedule, systematic investment plans remove the investor’s potential for making poor decisions based on emotional reactions to market fluctuations. For example, when stock prices soar and news sources report new market records being set, investors typically buy more risky assets.
In contrast, when stock prices drop dramatically for an extended period, many investors rush to unload their shares. Buying high and selling low is in direct contrast with dollar-cost averaging and other sound investment practices, especially for long-term investors.
SIPs and DRIPs
In addition to SIPs, many investors use the earnings their holdings generate to purchase more of the same security, via a dividend reinvestment plan (DRIP). Reinvesting dividends means stockholders may purchase shares or fractions of shares in publicly traded companies they already own.
Rather than sending the investor a quarterly check for dividends, the company, transfer agent, or brokerage firm uses the money to purchase additional stock in the investor’s name.
Dividend reinvestment plans are also automatic—the investor designates the treatment of dividends when they establish an account or first buy the stock—and they let shareholders invest variable amounts in a company over a long-term period.
Company-operated DRIPs are commission-free. That's because no broker is needed to facilitate the trade. Some DRIPs offer optional cash purchases of additional shares directly from the company at a discount with no fees. Because DRIPs are flexible, investors may invest small or large amounts of money, depending on their financial situation.
Advantages and Disadvantages of SIPs
Advantages
SIPs provide investors with a variety of benefits. The first, and most obvious, benefit is that once you set the amount you wish to invest and the frequency, there's not much more to do.
Since many SIPs are funded automatically, you just have to make sure the funding account has enough money to cover your contributions. It also allows you to use a small amount so you don't feel the effects of a big lump sum being withdrawn all at once.
Because you're using DCA, there's very little emotion involved. That cuts back some of the risk and uncertainty you're likely to experience with other investments like stocks and bonds. And since it requires a fixed amount at regular intervals, you're also implementing some discipline into your financial life.
Disadvantages
Although they can help an investor maintain a steady savings program, formal systematic investment plans have several stipulations. For example, they often require a long-term commitment.
This can be anywhere from 10 to 25 years. While investors are allowed to quit the plan before the end date, they may incur hefty sales charges—sometimes as much as 50% of the initial investment if within the first year. Missing a payment can lead to plan termination.
Systematic investment plans can also be costly to establish. A creation and sales charge can run up to half of the first 12 months' investments. Also, investors should look out for mutual fund fees and custodial and service fees if applicable.
Pros
"Set it and forget it"
Imposes discipline, avoids emotion
Works with small amounts
Reduces overall cost of investments
Risks less capital
Cons
Requires long-term commitment
Can carry hefty sales charges
Can have early withdrawal penalties
Could miss buying opportunities and bargains
Systematic Investment Plan vs. Lump Sum Investment
While SIPs are a systematic investment plan that involves investing a fixed amount at regular intervals, lump sum investments involve investing a large sum of money at once into a particular investment or asset class.
SIPs help to average out the purchase price of investments over time, reducing the impact of short-term market volatility. Lump sum investments are made at a specific point in time, so their performance depends on the market conditions prevailing at the time of investment.
Lump sum investments are potentially subject to a higher risk of losses, though that comes as potentially higher opportunities. For example, if the investment is made during a market downturn, the investor may experience immediate losses.
However, if the market performs well, a lump sum investment can yield higher returns compared to SIPs should the underlying investments have been purchased over a period of time where prices increased.
SIPs also provide a disciplined approach to investing and enable investors to mitigate the impact of market fluctuations. There is a psychological element to consider regarding committing to investing a certain amount of money each period.
Though this amount may be auto-drawn each period, investors may find mental solace in that they are consistently and constantly putting money away towards an investing strategy.
Example of a SIP
Mostbrokerages and mutual fund companies such as Vanguard Investments, Fidelity, and T. Rowe Price offer SIPs, allowing investors to contribute quite small amounts.
Although the payments can be made manually, most SIPs are set up to be funded automatically either monthly, quarterly, or whatever period the investor chooses. This means an investor should have a money market or other liquid account to fund their systematic investment plan.
T. Rowe Price calls its SIP product Automatic Buy. After the initial investment to establish the account—generally $1,000 or $2,500, though this usually varies depending on the type of account—investors can make contributions of as little as $100 per month. It is available for both IRA and taxable accounts, but only to purchase mutual funds—not stocks.
The payments can be transferred directly from a bank account, paycheck, or even a Social Security check. Note that there may be certain restrictions with Social Security payments, though the Social Security Administration has guidance on what are acceptable types of accounts.
Can I Start a SIP With a Small Amount of Money?
Yes, SIPs allow individuals to start investing with small amounts, making it accessible to a wide range of investors. The minimum investment amount varies depending on the mutual fund or investment provider.
What Investment Instruments Can Be Used for SIPs?
SIPs can be utilized to invest in various investment instruments such as mutual funds (equity funds, debt funds, hybrid funds), index funds, ETFs, and other investment products offered by financial institutions.
Can I Pause or Stop My SIP Investments?
Yes, investors have the flexibility to pause or stop their SIP investments at any time. They can choose to discontinue the SIP or pause it temporarily and resume later based on their financial circ*mstances or investment goals.
What Are the Costs Associated With SIP Investments?
SIP investments may involve certain costs such as expense ratios, which cover fund management expenses, and transaction charges. These costs are deducted from the invested amount or reflected in the NAV (net asset value) of the investment instrument.
What Returns Can I Expect From SIPs?
SIP returns are influenced by the performance of the underlying investment instrument. Over the long term, SIPs have the potential to generate attractive returns, especially when invested in equity-based funds, but it is important to note that returns are subject to market fluctuations.
The Bottom Line
Systematic investment plans are a disciplined investment approach that allows individuals to invest a fixed amount at regular intervals in selected investment instruments.
SIPs offer benefits such as regular investing, flexibility, the potential for dollar cost averaging, and the opportunity to start with small amounts. They provide individuals with a systematic and gradual way to invest, reducing the impact of market volatility and potentially generating long-term wealth accumulation.
