Systematic Investment Plan (SIP) Definition

A systematic investment plan (SIP) is a plan in which investors make regular, equal payments into a mutual fund, trading account or retirement account, such as a 401(k). The aim is to benefit from the long-term advantages of dollar-cost averaging (DCA), and the discipline and the convenience of saving regularly without taking any action except the initial setup of the SIP.

Most brokerages and mutual fund companies, such as Vanguard Investments, Fidelity, and T. Rowe Price, offer SIP, allowing investors to contribute quite small amounts. A money market account or other liquid account is typically used for funding the payments to or buying shares for the systematic investment plan. Although the payments can be made by hand, most SIPs are set up to be funded automatically each month, quarter or whatever time period the investor chooses.

Systematic investing basically works on the principal of dollar-cost averaging, an investment strategy implementing the regular and periodic purchasing of shares or units of a security. Dollar-cost averaging involves buying the same fixed-dollar amount of a security regardless of its price at periodic intervals. 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).

With this approach, DCA advocates argue, the average cost per share of the security decreases over time. Of course, the strategy can backfire if you have a stock, say, whose price steadily and dramatically mounts: That means investing over time costs you more than if you had bought all at once, at the outset. Overall, DCA usually reduces the overall cost of an investment; the risk of investing a large amount of money into a 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 of time, 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.

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 for purchasing 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.

Because there is no broker required for facilitating the trade, company-operated DRIPs are commission-free. 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 large or small amounts of money, depending on their financial situation.

Although they can help an investor maintain a steady savings program, formal systematic investment plans have several stipulations. For example, they often require a long-term commitment, anywhere from 15 to 25 years. Quitting the plan before the end date, while allowed, can incur a hefty sales charges, sometimes as much as 50% of the initial investment if within the first year. Missing a payment can lead to plan termination.

Systematic investment plans can also be costly to establish. A "creation and sales charge" can run up to half of the first 12 months' investments. In addition, investors should look out for mutual fund fees and custodial and service fees if applicable. 

T. Rowe Price calls its SIP product the Automatic Asset Builder. After the initial investment to establish the account (which varies depending on the type of account, but is generally $1,000 or $2.500), investors can make contributions of as little as $100 per month. It is available for both IRA and taxable accounts, but only to purchase mutual funds (not stocks). The payments can be transferred directly from a bank account, paycheck or even a Social Security check: "No checks to write or investment slips to mail—we handle everything," the company site promises.