February 06 , 2013
Mutual fund investing cannot (and should not) be a stand-alone activity; rather it forms a part of your financial diet. For a beginner, we recommend index funds since they require no research. Let's look at one strategy that uses this single product and convert it into a solid investment strategy.
If you are salaried, and not find much time or enthusiasm for investing regularly, a single investment strategy works wonders for you. This is called the Systematic Investment Plan (SIP). Let us assume you choose the Franklin India Index Fund Nifty Plan. In this, along with the application, you authorize the fund to deduct a fixed amount every month from your bank account, and add it to the fund. This kills several birds with one stone:
1. It instills discipline - If you were left to your discretion, you would miss out on investing - you may simply forget, you may think of some consumption items to buy instead, or you may be plain lethargic. In an SIP, the amount goes automatically without you needing to remember and attend to it.
2. It simplifies the process - Most of us don't want to think about our finances every now and then. We would all like the 'Fill it, shut it, forget it' philosophy, if that were possible! Indeed, with the SIP in an index fund, it is exactly this benefit at work - no need for research, no need for regular maintenance and monitoring.
3. It averages market fluctuations - In an SIP, the amount you invest is fixed every month, whether the market is high or low. This is like buying Rs 100 of apples every month. If the apples we an expensive Rs 20 one month, you would get only five of them. If prices fell to Rs 10 the next month, you get 10 of them. This way, you automatically end up buying more apples when prices are low. This benefit of the SIP, in technical jargon, is called Rupee-cost-averaging.
The only precaution to take in an SIP is to not stop it in panic when the market falls. Indeed, the biggest benefit of an SIP is that you buy more units when the market is low. If you stop it precisely then, you are certain to lose money.
In summary, for salaried people, a simple investment strategy is all it takes to make the most of the benefits of mutual funds. Start early, take about 25% of your monthly salary and start an SIP into an index fund. Keep the SIP going throughout your working career. It is amazing how many cash flow problems of life would cease to exist if only this simple strategy were followed!