Mutual funds are often described as a basket of stocks or bonds, depending on the fund's investment objectives, managed by a professional with shares of the portfolio made available for purchase by investors. At the end of each trading day, all the fund's holdings are priced and the fund's net asset value is calculated. Purchases of mutual funds can be made with lump-sum investments or through a systematic investment plan (SIP).
- A systematic investment plan involves investing a consistent sum of money regularly, and usually into the same security, which could be a mutual fund or funds.
- 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, buying more shares when prices dip.
- Most mutual fund companies offer SIPs.
Mutual funds are investment vehicles that pool money from many investors and then put that money to use following a stated strategy. For example, one mutual fund may be interested in generating extra returns by identifying under-valued small-cap stocks with high growth potential by undertaking in-depth research. Another mutual fund may instead seek to simply replicate the S&P 500 index in a passive manner. Either way, mutual funds allow investors to get professional money management across a range of strategies and investment styles.
Buying mutual fund shares can be done as a one-off transaction, or investors can choose to accumulate more mutual funds shares over time. Thus, we turn to systematic investment plans as a way to accomplish the latter.
A systematic investment plan (SIP) is a plan where investors make regular, equal payments into a mutual fund, trading account, or retirement account such as a 401(k).
An SIP involves an investor contributing a set dollar amount on a regularly scheduled basis. For example, you might set up a SIP to buy $100 per month worth of ABCDX mutual fund. Each month, on the specified date, you would have that buy order executed. This way of investing offers two key advantages: easy saving and buying shares consistently even when the markets are down - enabling better prices on average.
Setting up an SIP make it easier to budget for retirement and other investment goals. When you work a small amount into a monthly budget, it becomes more likely that you stick with the plan, making it easier to achieve your investment goals. For example, it is relatively easy to commit to investing $100 per month for retirement savings, but coming up with $1,200 at one time may be more difficult.
Through buying shares of a mutual fund on a regular basis, you can reduce the average cost per share. Market fluctuations over time are likely to present opportunities where shares are purchased at a lower price. This technique, called dollar-cost averaging, is a widely used strategy by many investors and is recommended by financial advisors.
What the Experts Have to Say:
Dan Stewart, CFA®
Revere Asset Management, Dallas, TX
A systematic investment plan, or SIP, simply means making periodic and scheduled contributions to your investment account or a specific security. Dollar-cost averaging is a SIP in its simplest form.
For example, investing $500 per month total in two different mutual funds of $250 each would be a SIP. But a SIP is not an investment strategy like a mutual fund. A mutual fund is a professionally managed fund in which the manager invests according to the fund's prospectus.
While the SIP is a great way to invest when growing your assets, once you accumulate a decent amount of wealth and are, say, nearing retirement, you may want to consider some type of defensive strategy that involves more active management.