A systematic investment plan, as defined by various investment experts, is an investment vehicle that allows investors to pay equal amounts at regular intervals to the mutual fund scheme of their choice. It is quite similar to the recurring deposit schemes offered by banks; the only difference is in the rate of return. While recurring deposits have a fixed rate of return, say close to 9%, returns on SIP can range from 10% to 35% and more.
Calculating the profitability of a SIP is a tedious task. But, MS Excel comes as a useful solution for the users who want to know what they will get at the end of the investment term. To calculate SIP returns, start by entering a sum of $100 from row 1 to row 12. As the cost of purchasing SIP varies (due to fluctuation in cost price), the number of units allocated changes accordingly. So you get a different value under the ‘Market Value’ heading each time. The total of all market values (= NAV * no. of units) is the final amount you receive at the end of the SIP plan.
SIP takes the time value of money in the calculation. Money tends to lose its value over a period due to rising inflation. So, to find out how SIP fares better than other investment alternatives, you can compare the IRRs of these. To understand the IRR, let’s first understand the NPV.
NPV stands for Net Present Value. The NPV tends to decrease at the same rate as inflation. It is believed that the NPV can reach the zero value in the course of time. So, the rate at which the NPV becomes zero is the IRR.
The formula to calculate returns in SIP is something like this:
GO = GO of the Cash Flow in the investment{Cash Flow / (DR +1)^n}
GO = net present value
Cash flow = cash value of alternative investment
DR = discount rate (mainly inflation rate)
n = no. of years
The SIP ROI is calculated using the IRR function. If you compare the IRR of a recurring deposit where the rate of return is constant, with that of SIP, you will find that SIP has a lower IRR than RD. That is why the return of SIP is mostly higher than RD for a given period.
SIP has higher returns than fixed and recurring deposits. But it is subject to a variety of charges, as well as market risks. However, if market risk is a concern, then the investor can opt for a variety of SIP plans that invest more in the debt markets than in market-linked capital. So, if you want to enjoy the benefits of volatile markets without exposing yourself to too much risk, you can choose to invest in SIPs over the company’s stock.
To conclude, if you are willing to take a calculated risk, you should opt for Systematic Investment Plans. All fund houses provide SIP yield calculators to find out how much money you will earn on your savings.
