Investment Strategies
Everybody earns, and most people save. But very few people invest, and even fewer invest wisely and efficiently. Why are most peoples investments hardly worth anything by the time they retire Why are most people indebted so badly Why is it so The answer is lack of planning and strategy.
In most walks of life and in all organizations, planning is a very important process. Why, because a well thought and effective plan leads to better implementation and results. Similarly with investments. When one can plan and save and invest properly why do so in a hap hazard manner. A well planned out investment strategy would lead to more focused, well directed investments meant towards fulfilling certain goals of life, thereby achieving it easily. Therefore one must adopt this strategy towards saving, investing and personal finances in ones life. It will lead to much better directed, planned and more efficient investments.
One of the most efficient ways to go about trying to invest, especially in equities, is via the SIP route. SIP, or Systematic Investment Planning, is a very effective investment strategy based upon the concept of Dollar Cost Averaging. It is meant specially for making investments in equity via the Mutual Funds route, but if one wants, one can apply the concept to any type of investment.
When the question of investing in equity arises, the foremost question that crops is of risk and return. Although equities provide the best return across asset classes, most people shy away from investing in equities because of their volatility. Not only that, most small investors tend to buy equities almost invariably at market tops, thus having to contend with losses on most of their equity investments. SIP tends to work around all of these problems. It lets investors invest small amounts every month to create meaningful wealth.
The methodology
The investor chooses to invest a particular amount every month in a fund of his choice. Say for example, the investor chooses to invest 500 dollars per month or any other amount of his/her choice, and keeps investing for a long period of time.
There are a lot of inherent advantages with this strategy:
Firstly, it is an effective way to save and invest. Saving a fixed amount every month forms a regular and good saving habit, making sure the investor keeps aside a little bit regularly for creating an investment corpus.
Secondly, it tackles the problem where most investors almost always buy at market tops. Market timing is very difficult thing to do, and even the most expert of people is not able to do so. Therefore, a better way is to invest a little bit every month, so that ones investments get spread over a large period of time, thereby ensuring that investor takes advantage of both highs and lows.
Thirdly, the mathematical concept of dollar cost averaging:
Suppose you buy 1000 worth of a stock which is quoting at 20. You will be able to buy 50 such units. Now suppose the price of it falls to 10. For the same 1000 now you would be able to buy 100 units. Now calculate your average purchase price. Most people would say instantly 15. But wait a little. You have invested 2000, and have got 150 units. Therefore your average cost works out to be 13.33
Thus you see how dollar cost averaging concept works to reduce your average cost.
How does this happen - simply, you buy more units when the price is less, and less when it is more. This when practiced over a long period of time leads to a much lower cost of units then one can achieve through normal investing. Fourthly, the concept of SIP, more than anything else, should be used to counter normal investor psychology. With most investors, time and again it has been seen that they tend to buy when markets are high and not when markets are low. It is this foregone opportunity where most investors loose out on most of their returns. Investing through SIP ensures that this does not happen.
Most people underestimate the power of compounding and investing for the long term. A monthly investment of 1000 dollars over a period of 20 years can fetch you how much at the end of 20 years. Make a guess. A hundred thousand dollars, a couple of hundred thousand dollars, at the max half a million dollars. This is what you could think of. Let me tell you how much it will actually amount to. A whopping 2 million dollars, assuming the investments generate an IRR of 20%, which is generally the case with such long term equity investments. Now imagine how much one could do with a couple of million dollars. This is the power of compounding and long term equity investing. This is how SIP works for you to let you enjoy higher and better returns.
But a caveat is necessary here. A SIP works best in an environment of volatile and fluctuations. But in a secularly bullish market, where equities consistently give good positive returns, a Sip could actually end up underperforming a lump sum investment. But then again who know how any market would behave in the future. This happens because the investment is made at one go in lump sum investments, and therefore reaps the full reward of bullish markets, but in SIP, the investment is made slowly, month at a time, to create a long term equity portfolio. But for an investor who is not an expert at predicting prices or who is not able to track market movements on a regular basis sip would be the best methods to invest.
Thus we see, taking into consideration all the positives of SIP, that it is an extremely efficient and in fact the best way to make investments in equities - regular small doses over a long period of time. Following the strategy for a number of years would reap rich dividends for the patient long term investor.
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