SIP is a Powerful Tool Against Volatile Markets: Here’s Why
Have you seen surfboarders ride effortlessly over the massive waves of the ocean? They have mastered the art of surfing. In the stock markets, traders need to master the art of trading to overcome the volatility of the markets.
But is there an easier way to beat volatility? Yes, there is a method that can help amateur investors save their wealth from eroding and even out the effects of a volatile market. SIPs are an effective option for investors to invest in highly volatile markets. This article aims to simplify the concept of SIPs and how it can help you reduce your risk.
SIP Overview & Pros
A Systematic Investment Plan (SIP) is a method of investing a certain amount every month in Mutual Funds. SIPs are best suited for investors with a regular monthly income that they want to invest. Investing regularly helps you to build a corpus to achieve major financial goals in your life. Experts recommend that you can derive optimum benefits from SIPs if you invest for a tenure exceeding 5 years.
A SIP not only reduces the bulk investment burden on your pockets but also helps you to average out your cost of investment. This is one of the major benefits of SIP. The margins might look small, but the difference is noticeable in the long term.
Pros
- Compounding Returns
Compounding returns over a long tenure make SIPs very attractive. When you pay your SIP installment, your earnings get reinvested. This brings the compounding effect into play, which helps you create more wealth.
- Low Investment
SIP is a fixed amount that you invest every month. This reduces the burden of lump-sum investment. You can decide to invest whatever amount you are comfortable with and still create your success journey using SIPs.
- Cost Averaging
When you invest regularly during various market cycles, you get more units when the prices are low and fewer units when the prices are high. This helps in reducing your average cost.
- Convenience
SIPs are very convenient. They do not require detailed market research and being proactive for every market move. This helps small investors to get a hold of their investments without extra effort. You can indulge in your regular financial activities alongside SIP investments.
Volatility
The market prices of stocks keep fluctuating with every transaction in the market. When these fluctuations become more frequent, and the stock prices experience dramatic rise and fall, it is called volatility. Higher volatility in stocks is very risky.
It becomes hard to determine the movement in stock prices. Investors with less knowledge of the market movements tend to lose huge chunks of their hard-earned money by making hasty decisions during such phases. Traders benefit from the sentiment-based decisions of these investors.
How Can SIP Help You to Beat Volatility?
Rupee Cost Averaging is a popular concept used by investors for many years. SIPs inherently achieve this without the investor making any added effort. Here is how this works. Let’s assume that you invest Rs. 10,000 every month for a year in a volatile market. The following table shows your investment pattern and the number of units you purchase.
| Month | SIP | NAV | Units |
| January 2021 | Rs. 10,000 | Rs. 10 | 1,000 |
| February 2021 | Rs. 10,000 | Rs. 12 | 833.33 |
| March 2021 | Rs. 10,000 | Rs. 20 | 500 |
| April 2021 | Rs. 10,000 | Rs. 25 | 400 |
| May 2021 | Rs. 10,000 | Rs. 15 | 666.67 |
| June 2021 | Rs. 10,000 | Rs. 18 | 555.56 |
| July 2021 | Rs. 10,000 | Rs. 22.50 | 444.44 |
| August 2021 | Rs. 10,000 | Rs. 20 | 500 |
| September 2021 | Rs. 10,000 | Rs. 10 | 1,000 |
| October 2021 | Rs. 10,000 | Rs. 12 | 833.33 |
| November 2021 | Rs. 10,000 | Rs. 15 | 666.67 |
| December 2021 | Rs. 10,000 | Rs. 25 | 400 |
| Total | Rs. 1,20,000 | 7800 |
You can easily see the benefit you get at the end of the year.
- Average cost per unit is Rs. 15.3846 (Rs. 1,20,000 / 7800).
- Gain per unit is Rs. 9.6154 (Rs. 25 – Rs. 15.3846)
- Total Gain is Rs. 75,000 (7800 x Rs. 9.6154)
This example shows that investors can beat market volatility by investing in SIPs. Suppose you had invested your total money at once in April 2021 at a NAV of Rs. 25. You would have purchased only 4800 units (Rs. 1,20,000 / Rs. 25).
Investing in SIP not only reduces your cost but also allows you to purchase more units if prices are low and fewer units if prices are high. So, automatically, your portfolio starts to grow.
Key Takeaways
- SIP is a method of investing a fixed amount every month in mutual funds.
- Heavy fluctuation in the prices of a stock is called volatility.
- Investing regularly in SIPs can help you beat the effects of volatility.
- SIPs can save your wealth from erosion and help you earn higher returns.