Systematic Investment Plans
A systematic investment plan is a process whereby an investor invests into a mutual fund (or some other investment or investment account such as a 401k plan) on a regular systematic basis. The investment is the same amount each period, and the periods are always the same (monthly, quarterly, yearly etc.).
For example, Investor A invests $200 per month into mutual fund XYZ each month on the first day of each month automatically. That is a systematic investment plan. The investor always invests the same amount into the same investment on the same day (or same period length). Consistency is the key here, a systematic investment plan must adhere to the rules.
I’ve written about systematic investment plans here before, so I’m going to focus more on why a systematic investment plan makes sense for your investment program.
A systematic investment plan has some great advantages. It allows the investor a few things:
- Removes emotion from the decision to invest. When an investor must decide when to invest, they always look for reasons not to invest. “Now” is always the hardest time to invest. If the market was up yesterday the investor may think it’s high and defer the investment until the market goes down (which may never happen). If the market was down yesterday the investor may defer the investment until the market stops dropping (and miss an upswing or invest in at higher prices). A systematic investment plan effectively removes the emotion from the decision on when to invest because to be “systematic” a regular recurrent date must be set for investment, and that date must be adhered too.
- Lower average cost per share. You may remember from my prior post on systematic investment plans that in volatile markets it produces a lower average cost per share than the actual average price per share. Here’s how it works, Investor A invests $200 per month each month on the same day into a mutual fund (or collective pool of mutuals such as with a 401k plan account) and purchases shares at the following prices. This gives them a lower average cost per share because they buy more shares when prices are low and fewer shares when prices are higher:
|Investment Date||Amount Invested||Share Price||Shares Purchased|
- Great investment growth and wealth building tool! Most systematic investment plans enjoy great long term growth not necessarily because of the investments themselves, but because the decision making process is on autopilot. The biggest problem investors face isn’t always picking the best investments, it’s sticking with a plan! A systematic investment plan forces the investor to stay engaged in a process rather than leave the decision making of investment timing and investment amount to randomness.
Disadvantages of Systematic Investment Plans
I mentioned the benefits of systematic investing, however there are disadvantages as well. In the example above, the investor would have invested $2,400 per year or a total of $24,000 over ten years. Let’s assume the investor earned 8% per year in whatever mutual fund or portfolio she chose for her systematic investment plan:
- If the investor had a $24,000 lump sum to invest on day one, in 10 years they would have a $51,814 nest egg.
- If the investor invested $200 a month per her systematic investment plan, she would have less money working for her over time, and her nest egg would be $36,833. That’s the time value of money working against her.
In lieu of having the lump sum to invest now, systematic investment plans are the perfect option! However if you have the lump sum to invest, investing now (while always the hardest time to invest) is the best option.
If you’re investing in the stock market to any extent, remember that since 1926 the S&P 500 has had positive returns 72% of the years through 2011. While it’s always hardest to invest now, the odds are against you if you wait to invest.