What Is SIP Investment & How SIP Works?
Picture yourself planting seeds and envision a well grown tree 10 years from now, yielding fruits and providing shade when needed the most. Investing through SIP works the same way. You invest small amounts consistently in a mutual fund scheme in a disciplined way and accumulate wealth over the long term that helps you fulfil your financial goals. Retail investors in India continue to plough money into mutual funds through this scheme. It is evident from the recent numbers that show approximately 7.13 crore SIP accounts through which investors invest regularly. As of September 30, 2023, the total amount collected through SIP stood at Rs. 16,042 crore. However, many investors are still unaware of investing in mutual funds through the Systematic Investment Plan. Let us understand what SIP, how it works, how to invest in it and the wide range of benefits associated with it.
Systematic Investment Plan (SIP)
Systematic Investment Plan (SIP) is a popular investment tool through which one can invest a fixed amount regularly (ideally monthly) in mutual funds in a systematic and disciplined manner. It is an alternative investment approach to making a lump sum investment. One can prefer to start an SIP either in an Equity or debt fund depending upon one’s risk appetite. However, most investors prefer equity funds for sip investment as it helps to accumulate wealth over the long term. Additionally, SIP also offers variants other than regular SIP which include Step Up SIP, Flexi SIP, Perpetual SIP, Trigger SIP etc.
How SIP works?
Let us understand the working of SIP through a simple example. Ram, a 27 year old bank employee, started an SIP of Rs.10,000 for a tenure of 5 years with an anticipated Rate of Interest (ROI) of 10%. Over the tenure of 5 years, he invested Rs.12,00,000. He earned estimated returns of Rs.8,65,520. Upon maturity, he was able to accumulate a corpus of Rs.20,65,520 which was otherwise not possible for him.
Ram was able to accumulate this corpus primarily due to four main factors on which the concept of SIP works.
Rupee Cost Averaging: When one buys units of a mutual fund, a price is associated with it referred to as Net Asset Value (NAV) of the fund that fluctuates daily. One buys more units of a mutual fund when the NAV is lower and fewer units when the NAV is high. In other words, during market downturns, one acquires more units, while fewer units are obtained during upswings. This averages the overall cost of purchasing the units of a mutual fund and helps one get less impacted by short-term market fluctuations.
Power of Compounding: The concept of SIP works on the foundation of this approach. In simple words, the interest earned by the investor gets reinvested in the original corpus. Each repetition of this process paves the way for the systematic accumulation of money that results in exponential growth over time.
Starting Early: Historical data suggests that no matter at what frequency the SIP instalment amount gets debited; one must start the SIP early and stay invested through it for a longer duration to achieve the benefits of compounding.
Investing Regularly: If you invest regularly in a SIP, even small amounts can accumulate into a significant corpus due to the compounding effect. Additionally, this approach also helps inculcate the habit of disciplined investing.
Advantages of Investing through SIP
Flexibility to choose date, amount & tenure: SIP is a highly flexible and affordable investment approach where one can invest in a mutual fund scheme of choice. One has the option to choose the SIP amount, date of deduction and tenure of the investment as per risk appetite and financial goal. For short-term goals, one can invest in low-risk options such as debt or money market funds. For medium-term goals, exploring alternatives like Balanced Advantage or Hybrid Equity Funds can be advantageous. On the other hand, for mid to long-term investments, it is advisable to allocate funds to equity funds. Furthermore, SIP also offers the flexibility to top up the investment amount through a feature called ‘Step Up’ where one can increase the amount in line with income growth and halt as needed.
Cost & Convenience: One can start an SIP with as low as Rs. 100 and gradually increase the investment as the financial situation improves. It is a hassle free investment and just needs a few steps to begin. Once all sip related documents are ready (Proof of Identity, Proof of Address, PAN Card and investors’ bank account details), it is important to conduct KYC (online or offline) and sign up for the NACH (National Automated Clearing House) mandate. Once all this is set up, SIP allows automatic deductions from the investor’s bank account on the date chosen by the investor.
No need to time the market: SIP allows one to invest a fixed amount regularly across different market levels without having to time the market. This means that the investor does not need to worry about market cycles or check whether the time is right to invest. Additionally, cost averaging allows short-term market fluctuations to have less impact on the investments.
Professional Management: SIP in Mutual funds are managed by highly experienced and well trained finance professionals who choose a mutual fund scheme that aligns with one’s investment objectives and risk tolerance.
Calculate Estimated Returns: Most fund houses and financial institutions provide SIP Calculator ,a highly useful online tool that helps investors estimate the potential returns on their SIP investments. This aids in better financial planning and decision-making for the investor. These calculators are free of charge and anyone can access them online from websites.
Alternative Investment Strategies
In addition to SIP, alternative investment methods like SWP (Systematic Withdrawal Plan) and STP (Systematic Transfer Plan) can be explored. Each approach brings unique benefits to investors. SWP, for instance, is well-suited for generating supplemental income from investments during retirement or for cash flow management. In contrast, STP facilitates the transfer of a predetermined amount from one mutual fund scheme to another, typically involving a transition from a lower-risk option, such as a debt fund, to a higher-risk equity fund.
However, it is crucial to remember that SIP is designed for long-term gains, and consulting with a financial expert is highly recommended. A professional advisor can help you pick the right mutual fund, decide on the ideal SIP duration and craft an investment strategy that helps you achieve your financial goals.