It means averaging the cost price of your investments.

SIP helps in averaging the cost as equal amount is invested regularly every month at different NAVs. SIP works well in a volatile market as in the months where markets are down you get more number of units as the NAV is down and when the markets are up you get less number of units. But over all the prices gets averaged out.

Let us see how: Say you make your first investment of Rs 1,000 at a NAV of Rs 10. In this case, the units acquired will be 100 (1,000/10). You make the next investment of Rs 1,000 at a NAV of Rs 12. Units acquired now will be 83.33333 (1,000/12). Now also suppose that you make the third investment of Rs 1,000 at a NAV of Rs 9 and the units acquired will be 111.1111 (1,000/9).

The average purchase cost works out to Rs 10.19 (3,000/294.4444).

This concept, however, may not work in a rising market. As the markets are constantly rising you acquire less and less units and the average cost does not work in our favour.

If you compare the returns of SIP investments to non-SIP investments from May 2005 to January 2008 between which the markets moved up from 6,000 to touch 21,000, the returns of an equity diversified fund given by non-SIP investments are higher than SIP investments. Take an example of HDFC Equity Fund: