In investing, slow and steady wins the race. And with a systematic investment plan (SIP), you’ll have the best opportunity to successfully build wealth for the future. But what is a SIP investment plan and why is such an approach the most commonly used way for wealth building?
In this article, we will explain why long-term, systematic, and consistent investing is crucial to wealth building and why a SIP investment plan is the way to go for most successful investors.
Long term investing and compounding
Investing has always been at the heart of wealth building. Money invested in the market can earn returns, thereby making more money for the investor.
Here, compounding is the engine through which investing accomplishes the goal of wealth building.
By compounding we mean the ability of money to earn new money and for that new money to also earn new money, ad infinitum. For example, if investor A invests $1,000 in the market at a 5% annual return, the $1,000 will bring in $50 at the end of the year. For next year (year 2), both the $1,000 capital and the $50 interest will earn an additional (and assumed) 5% interest for the year. And this goes on and on.
Consequently, the longer the time you stay in the market, the more chance you’ll have of earning compound returns and building wealth.
And since the stock market rises more than it falls, you can be confident that your money will grow over the long term. Yes, there will be short-term downturns, but there will be recoveries and over the long term, your investment will be worth more than it was at the beginning.
If Investor A above leaves the market at the end of Year 2, he would have made less money than if he continued to earn compound return until Year 5. The original capital will continue to earn interest and every new interest will also continue to make new interest ad infinitum.
It is no wonder then that successful investors who have made a name building wealth in the stock market have always advised that investors stay in the market for the long term rather than focusing on short term profit. You might earn some income in the short time but when it comes to building significant wealth, time is your best friend.
Long term, systematic, and consistent investing
In the example above, we saw how investor A can generate a lot of compound returns by leaving his $1,000 in the market for the long term. Now consider another situation: In addition to getting compound returns on the initial $1,000, investor A is also consistently adding an extra $1,000 every month from his salary.
With this, instead of one channel of investing, investor A can create twelve different channels of investing. Said differently, instead of one $1,000 earning compound returns ad infinitum, he will be doing this twelve times over. If he invests $1,000 at the end of every month for Year 2 as well, now there are twenty-four amounts of $1,000 that are earning compound returns.
The result is more wealth-building opportunities.
For example, $1,000 invested in a market that earns 5% annual interest (of our assumed return rate) will become $1,283.36 at the end of Year 5, with monthly compounding. On the other hand, $1,000 invested consistently at the end of every month with 5% annual interest and monthly compounding will become $69,289.44 at the end of Year 5. The humongous difference between these two is the power of $1,000 invested systematically and consistently at the end of every month.
Therefore, while investing for the long term is a good way to build wealth, combining that long-term focus with a consistent and systematic approach to investing is the best way.
The need for a systematic investment plan (SIP)
An SIP brings these three components together. This plan requires that you consistently invest a specific (definite) amount (as a percentage of your income) every month for a long-term period.
For example, if you use the 50/30/20 rule, this might mean consistently setting aside 20% of your monthly income and investing it immediately into the market. By doing this, you will earn multiple compound returns on multiple investments for a long time.
SIP and emotional investing
With a SIP, you don’t need to worry about the ebbs and flows of the stock market. Many investors lose money in the market because they are driven by the wind of short-term market volatility.
Warren Buffett calls this the free-greed cycle. In this cycle, people enter into the market because the price is rising and once price starts falling, they quickly sell like others. In the end, they buy high and sell low, losing money in the process.
No wonder that Buffett insists that temperament is more important than intellect when it comes to investing. The long-term, systematic, and consistent approach of a SIP helps you avoid the fear-greed cycle. With it, you can focus on the long-term growth of your funds since over the long term, the market rises more than it falls.
With a digital financial advisor like Sarwa, you can use a SIP by investing a consistent portion of your income every month in an investment portfolio created specifically for you using the Nobel Prize-winning Modern Portfolio Theory.
To make things easier, Sarwa gives you the option to automatically deduct your monthly investment when your income arrives in your account. In this way, you can easily overcome the temptation to spend what you should invest. That is, Sarwa can help you deny yourself today so you can build wealth for the future.