What is Systematic Investment Plan (SIP)?
A Systematic Investment Plan is a mode of investment which allows you to invest a fixed amount of money in any mutual fund scheme at regular intervals — for example, on a monthly or quarterly basis. It is similar to a Recurring Deposit (RD) in a bank, but the difference is that your money will be invested in a mutual fund scheme, which may mean it is headed for the equity markets or debt instruments. SIPs are offered by most mutual fund houses in India and all over the world.
SIPs have proven to be a reliable wealth creation tool for those who invest. They bring financial balance and discipline to your investment and assist you in achieving your long-term goals – such as retirement planning, children’s education, buying a house, etc.
How is SIP different from other mutual funds?
Generally, there are two types of investments you can make into a mutual fund: lump sum and SIP.
A lump sum investment is a one-time investment with a mandatory lock-in period. You will need a big corpus if you want to invest lump sum amount into a mutual fund scheme. If you receive money after retirement or by selling your house or from an inheritance, you can consider doing a lump sum investment with the same.
On the other hand, the alternative investment is the option of SIP. Under SIP you can determine a smaller sum to invest at regular intervals. This is very useful for salaried individuals where they can build a substantial corpus for various financial goals over a long period of time.
How does SIP work?
SIP handled by market experts who manage large funds across various asset classes.
- Once the investor chooses the scheme he/she wants to invest in and pays the amount, the fund house allocates a certain number of units of that scheme depending upon the Net Asset Value (NAV) as of purchase date
- As the amount invested by the investor remains the same for each installment for a specified duration, the number of units of the scheme bought for every installment differs. SIP reduces the average cost of investment by buying fewer units during the rising market and more units while the market declines. This is called rupee-cost averaging.
- The returns in SIP are paid either as a dividend or it is again invested in SIP. Investor has an option to choose this as well. Hence, for a long-term compounding effect to happen, an investor can choose to reinvest the returns from SIP and get more returns.
How to select the best SIP?
To select the best mutual fund scheme and get started with a SIP, you must keep the following things in mind:
- Financial Goals: An activity yields the best results if it is started with a specific, measurable and achievable goal. To select a suitable SIP, it is important to have your financial goals in place.
- Performance of funds: It is important to look at the previous trends of the fund, its category, dividend yield etc. This will help you understand how the fund house handled previous ups-and-downs of the market.
- SIP Duration: Duration of SIP is an important factor to consider while investing in a risky and tax-levying business. You can keep a reference point of 3 or 5 years and understand the performance of funds across markets. You can also use SIP Calculator that calculates the amount of money you can earn by investing for a certain duration.
- Choose a direct plan for better results: Mutual Fund schemes are available in two variants: a Direct Plan and a Regular Plan. The Direct Plan has a lower expense ratio than Regular Plans as it doesn’t involve a distributor, so you will get better returns if you opt for a Direct Plan. These savings in return will be added to your scheme and available to buy more units.While the amount saved in commissions might be low on a monthly basis, the effect of compounding over a large number of years can provide significant returns on the savings.
- Choose Dividend or Growth Plans as per your need: After you decide which mutual fund scheme you want to start with, choose between Dividend and Growth options. If you want regular income, choose the dividend option. Else, go for the growth option if you want your dividends to be reinvested in the scheme.
How is SIP better than Lump Sum Investment?
- No big investment: You can invest small amounts of money in SIPs at regular intervals — even as low as ₹500 per month. On the contrary, minimum amount for lump sum investment in a mutual fund is typically ₹5,000.
- No worries about market timing or market crash: SIP investments are a good option for eliminating the worries of entering the market at the right time. You don’t have to worry about the highs and lows of the market. Staying invested for a long time using SIPs can even-out the volatility of the stock market.
- Rupee-cost averaging effect: The rupee-cost averaging reduces the factor of volatility. It helps you buy more units when the price is lower and fewer units when the price is higher. Rupee-cost averaging nullifies the effect of short-term market fluctuation on your investments and hence, is considered to be one of the major factors for SIPs to be favourable for long-term investments.
- Power of compounding: The money that gets invested regularly and systematically through SIPs is compounded over time through regular investments. The quicker you start, the more compounding impact you can see.
For example, If you started saving ₹1,000 a month on your 30th birthday, in 30 years time you would have put aside ₹3.6 lakhs. If that investment grew by an average of 10% a year, it would be worth around ₹22.8 lakhs when you reach the age of 60.
However, if you started investing on your 20th birthday, the ₹1,000 a month corpus would be worth ₹4.8 lakh over 40 years. Assuming that the growth rate is 10% annually, your investment will be worth ₹ 63.8 lakhs on your 60th birthday. Isn’t that amazing? The amount you end up with can increase exponentially if you start investing a few years earlier.
- Convenience: It is fairly convenient to start a SIP investment. You can choose the interval as per your financial ability. You also have the option of skipping a SIP if you have insufficient funds.
- Future goal planning: We’ve all got future goals — buying a house, a dream car, children’s education, retirement, etc. If you don’t have a lot of knowledge about the stock market, SIPs can be low-risk best alternative for all your future goals.
- Disciplined investing: SIP investments encourage discipline and regularity in investments. They are a time-tested method for disciplined investing that yielded great results.