Investing would be simple if you could always pick the best time to buy and sell. However, timing the market consistently can be a difficult task and you could be hit with a loss sooner or later. What you need is an automatic market-timing mechanism that eliminates the need to time your investments.
As such, you don't have to worry about where share prices or interest rates are headed. You simply invest a fixed amount at regular intervals, regardless of the NAV. The idea is that you buy fewer units when the NAV is high and more when it is low - automatically. This is in line with our natural desire to buy low and sell high.
For instance, you could opt for a Systematic Investment Plan (SIP) by investing Rs 1000 every month into an open-ended equity scheme with an NAV of Rs. 10/-. The table above shows us that the average cost per unit under the SIP will always be less than the average purchase price per unit, regardless of whether the market is rising or falling or fluctuating.
The table below pits two investors against each other. Both start their investments in equity at the same time. One of them makes a lump sum investment of Rs. 60,000/- while the other invests the same amount but in multiples of Rs.10,000/- each month for six months.
This example uses assumed figures and is for illustrative purposes only. *Fractional units rounded off.
During the course of the six month period, the lump sum investor sees the unit price of his shares fall far below his cost of acquisition, followed by an equally spectacular rise. At the end of six months however, his price per unit happens to be the same as when he invested. His portfolio has effectively stood still for six months.
On the other hand, the SIP investor has regularly invested, regardless of price movements. His entire capital is not at risk, since it is being 'drip-fed' into the market, one bit at a time. That amount buys a different number of shares each time; fewer shares when the price climbs, and more when it drops. The net result is that after six months, the price of his shares is at the same level it was when he started, but he has actually acquired more shares than the lump sum investor, because he was able to take advantage of the dips in price! His portfolio has grown, while the lump sum investor's portfolio has remained stagnant.
In this way, the inherent volatility of equity prices is used to enhance returns, while reducing the time your entire capital is actually exposed to the market. Let us look at a real-life example to see how a systematic investment plan affects returns on a portfolio.