What's a mutual fund SIP?

What type of a mutual fund is a SIP?

I was taken aback by this question before I realised the person posing it thought a SIP was a type of mutual fund.

Unfortunately, many new investors seem to be under this misconception.

A Systematic Investment Plan is not a type of mutual fund. It is a method of investing in a mutual fund.

Here's to coming to terms with it.

How you can invest in a mutual fund

There are two ways in which you can invest in a mutual fund.

1. A one-time outright payment

If you invest directly in the fund, you just hand over the cheque and you get your fund units depending on the value of the units on that particular day.

Let's say you want to invest Rs 10,000. All you have to do is approach the fund and buy units worth Rs 10,000. There will be two factors determining how many units you get.

Entry load

This is the fee you pay on the amount you invest. Let's say the entry load is 2%. Two percent on Rs 10,000* would Rs 200. Now, you have just Rs 9,800 to invest.

NAV

The Net Asset Value is the price of a unit of a fund. Let's say that the NAV on the day you invest is Rs 30.

So you will get 326.67 units (Rs 9800 / 30).

2. Periodic investments

This is referred to as a SIP.

That means that, every month, you commit to investing, say, Rs 1,000 in your fund. At the end of a year, you would have invested Rs 12,000 in your fund.

Let's say the NAV on the day you invest in the first month is Rs 20; you will get 50 units.

The next month, the NAV is Rs 25. You will get 40 units.

The following month, the NAV is Rs 18. You will get 55.56 units.

So, after three months, you would have 145.56 units. On an average, you would have paid around Rs 21 per unit. This is because, when the NAV is high, you get fewer units per Rs 1,000. When the NAV falls, you get more units per Rs 1,000.