A systematic investment plan (SIP) is used to invest a specified dollar amount on a predetermined schedule. For example, you may choose to set up an SIP to purchase $100 per month worth of a mutual fund. Using this type of investment strategy has many benefits, including dollar-cost averaging and simple budgeting. However, it also carries a few risks, such as giving up full market participation and possibly higher transaction costs.
One of the main benefits and reasons why investors choose a SIP for investing is based on the theory of dollar-cost averaging. This method assumes that, over time, you can reduce your average cost per share by investing at regular intervals over a period of time, thereby catching fluctuations in the market. For example, if you choose to purchase $100 worth of a stock each month, you may end up with 25 shares at $4 per share, 50 shares at $2 per share and 20 shares at $5 per share. Instead of purchasing only 75 shares at $4 per share at the beginning, by splitting up the $300 investment and investing over three months, you have 95 shares at an average cost of $3.15 per share.
There are some drawbacks to using an SIP for investing. The dollar-cost averaging scenario mentioned above could very easily result in a higher average cost per share if the share price rose steadily to $10 over that period of time. The SIP would have created a higher average cost, and it would also eliminate the profit that could have been realized if you had invested the entire $300 initially at $4 per share.