What Is a Systematic Investment Plan (SIP)?

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). SIPs allow investors to save regularly with a smaller amount of money
while benefiting from the long-term advantages of dollar-cost averaging (DCA).
By using a DCA strategy, an investor buys an investment using periodic equal
transfers of funds to build wealth or a portfolio over time slowly.

KEY TAKEAWAYS

 A systematic investment plan involves investing a consistent sum of

money regularly, and usually into the same security.
 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.
 Most brokerages and mutual fund companies offer SIPs.
How SIPs Work
Mutual fund and other investment companies offer investors a variety of
investment options including systematic investment plans. SIPs give investors a
chance to invest small sums of money over a longer period of time rather than
having to make large lump sums all at once. Most SIPs require payments into the
plans on a consistent basis—whether that's weekly, monthly, quarterly.

SIPs allow investors to use smaller amounts of money with the benefits of dollar-
cost averaging.
The principle of systematic investing is simple. It works on regular and periodic
purchases of shares or units of securities of a fund or other investment. Dollar-
cost averaging involves buying the same fixed-dollar amount of
a security regardless of its price at each periodic interval. As a result, shares are
bought at various prices and in varying amounts—though some plans may let
you designate a fixed number of shares to buy. Because the amount invested is
generally fixed and doesn't depend on unit or share prices, an investor ends up
buying fewer shares when unit prices rise and more shares when prices drop.

SIPs tend to be passive investments, because once you put money in, you
continue to invest in it regardless of how it performs. That's why it's important to
keep an eye on how much wealth you accumulate in your SIP. Once you've hit a
certain amount or get to a point near your retirement, you may want to reconsider
your investment plans. Moving to a strategy or investment that's actively
managed may allow you to grow your money even more. But it's always a good
idea to speak to a financial advisor or expert to determine the best situation for
you.

Special Considerations
DCA advocates argue that with this approach, the average cost per share of the
security decreases over time. Of course, the strategy can backfire if you have a
stock whose price rises steadily and dramatically. That means investing over
time costs you more than if you bought all at once at the outset. Overall, DCA
usually reduces the cost of an investment. The risk of investing a large amount of
money into security also lessens.

Because most DCA strategies are established on an automatic purchasing

schedule, systematic investment plans remove the investor’s potential for making
poor decisions based on emotional reactions to market fluctuations. For example,
when stock prices soar and news sources report new market records being set,
investors typically buy more risky assets. In contrast, when stock prices drop
dramatically for an extended period, many investors rush to unload their shares.
Buying high and selling low is in direct contrast with dollar-cost averaging and
other sound investment practices, especially for long-term investors.

SIPs and DRIPs

In addition to SIPs, many investors use the earnings their holdings generate to
purchase more of the same security, via a dividend reinvestment plan (DRIP).
Reinvesting dividends means stockholders may purchase shares or fractions of
shares in publicly traded companies they already own. Rather than sending the
investor a quarterly check for dividends, the company, transfer agent or
brokerage firm uses the money to purchase additional stock in the investor’s
name. Dividend reinvestment plans are also automatic—the investor designates
the treatment of dividends when he establishes an account or first buys the
stock—and it lets shareholders invest variable amounts in a company over a
long-term period.

Company-operated DRIPs are commission-free. That's because there is no

broker needed to facilitate the trade. Some DRIPs offer optional cash purchases
of additional shares directly from the company at a 1% to 10% discount with no
fees. Because DRIPs are flexible, investors may invest small or large amounts of
money, depending on their financial situation.

Advantages and Disadvantages of Systematic Investment

Plans
Advantages
SIPs provide investors with a variety of benefits. The first, and most obvious,
benefit is that once you set the amount you wish to invest and the frequency,
there's not much more to do. Since many SIPs are funded automatically, you just
have to make sure the funding account has enough money to cover your
contributions. It also allows you to use a small amount so you don't feel the
effects of a big lump sum being withdrawn all at once.

Because you're using DCA, there's very little emotion involved. That cuts back
some of the risk and uncertainty you're likely to experience with other
investments like stocks and bonds. And since it requires a fixed amount at
regular intervals, you're also implementing some discipline into your financial life.