What Is a Systematic Investment Plan (SIP)?

A systematic investment plan (SIP) is one 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 ofdollar-cost averaging (DCA). An investor buys an investment using periodic equal transfers of funds to build wealth or a portfolio slowly over time when using a DCA strategy.

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 rather than having to make largelump sums all at once. Most SIPs require payments into the plans consistently, either weekly, monthly, or quarterly.

Systematic investing 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.

Shares are bought at various prices and in varying amounts as a result although some plans may let you designate a fixed number of shares to buy. The amount invested is generally fixed and doesn't depend on unit or share prices so an investor ends up buying fewer shares when unit prices rise and more shares when prices drop.

SIPs tend to bepassive investments because you continue to invest in them regardless of how they perform after you put money in.

It's important to keep an eye on how much wealth you accumulate in your SIP. You may want to reconsider your investment plans when you've hit a certain amount or get to a point near your retirement. Moving to a strategy or investment that's actively managed may allow you to grow your money even more. 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 the average cost per share of the security decreases over time with this approach. The strategy can backfire if you have a stock whose price rises steadily and dramatically. Investing over time costs you more than if you bought all at once at the outset.

Most DCA strategies are established on an automatic purchasing schedule so systematic investment plans remove the investor’s potential for making poor decisions based on emotional reactions to market fluctuations. Investors typically buy more risky assets when stock prices soar and news sources report new market records being set.

Many investors rush to unload their shares when stock prices drop dramatically for an extended period. 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

Many investors use the earnings their holdings generate to purchase more of the same security via adividend reinvestment plan (DRIP). Reinvesting dividends means stockholders may purchase shares or fractions of shares in publicly traded companies they already own. The company, transfer agent, or brokerage firm uses the money to purchase additional stock in the investor’s name rather than sending the investor a quarterly check for dividends.

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 because no broker is necessary to facilitate the trade. Some DRIPs offer optional cash purchases of additional shares directly from the company at a discount with no fees. Investors can invest small or large amounts of money depending on their financial situation because DRIPs are flexible.

Advantages of SIPs

SIPs provide investors with a variety of benefits. The first and most obvious is that there's not much more to do after you set the amount you want to invest and the frequency. Many SIPs are funded automatically so you just have to make sure the funding account has enough money to cover your contributions. A SIP 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.

There's very little emotion involved because you're using DCA. This cuts back some of the risk and uncertainty you're likely to experience with other investments such as stocks and bonds. You're also implementing some discipline in your financial life because it requires a fixed amount at regular intervals.

Disadvantages of SIPs

They can help an investor maintain a steady savings program but formal systematic investment plans have several stipulations.

They often require a long-term commitment that can be anywhere from 10 to 25 years. Investors are allowed to quit the plan before the end date but they may incur hefty sales charges, sometimes as much as 50% of the initial investment if they quit 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. Investors should also look out formutual fund fees and custodial and service fees if applicable.

Systematic Investment Plan vs. Lump Sum Investment

SIPs are systematic investment plans that involve investing a fixed amount at regular intervals. Lump sum investments involve investing a large sum of money all 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 but this comes with potentially higher opportunities. The investor may experience immediate losses if the investment is made during a market downturn.

A lump sum investment can yield higher returns compared to SIPs, however, if the market performs well and the underlying investments have been purchased over some time when prices have increased.

SIPs also provide a disciplined approach to investing. They enable investors to mitigate the impact of market fluctuations. There's a psychological element to consider with the commitment to invest a certain amount of money each period. This amount may be auto-drawn each period but investors might find mental solace because they're consistently and constantly putting money away toward an investing strategy.

Example of a SIP

Most brokerages and mutual fund companies such as Vanguard Investments,Fidelity, and T. Rowe Price offer SIPs, allowing investors to contribute quite small amounts.

The payments can be made manually but most SIPs are set up to be funded automatically, either monthly, quarterly, or another period the investor chooses. 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. Investors can make contributions of as little as $100 per month after the initial investment to establish the account, generally $1,000 or $2,500 but this usually varies depending on the type of account. It's 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 aSocial Security check. There may be certain restrictions with Social Security payments but the Social Security Administration provides guidance on acceptable types of accounts.

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 begin 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.

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