A Systematic Investment Plan (SIP) is a way of payment in a mutual fund scheme in which the investors pay periodically through regular installments. Many new investors wonder if SIP is a type of mutual fund scheme or any other investment tool. Well, it is not a new investment tool but simply a process of investment. It is an alternative mode of investment to that of a lump sum. You invest small installments of money in a fund scheme to build a corpus over time.
Understanding SIP – How do they work?
In mutual funds, the investors’ money is invested into several asset classes like stocks, bonds, gold, and other marketable securities. The professional fund managers research the market and check the performances of these money market instruments. They invest as per the objective of the fund. As these securities perform, their value rises and falls affecting the Net Asset Value (NAV) of the fund. NAV is per unit market value of the mutual fund; investors purchase these units by investing in a fund scheme. With lump-sum investment, investors purchase certain units at once whereas the SIP is a plan where investors will purchase units in a periodic phase.
SIP allows investors to invest in a mutual fund systematically through small periodic amounts whether it is weekly, monthly, or quarterly. Most fund schemes have monthly SIPs where the minimum investment value for the schemes may vary. They have the advantage that investors can plan their monthly installments as per their income and other cash inflows. The mantra for the SIP mode of investment is to start early and invest regularly.
Systematic Investment Plans (SIPs) are getting increasingly popular among young investors. This is because of the ease of investment and several other benefits. The features of the SIPs are mentioned below:
1. Small Investment Amount
SIPs can help investors who have no or lesser income such as students, homemakers, etc. to invest in mutual funds. With MF schemes, investors can start the SIP with a minimum monthly installment which can be as low as Rs. 500 and there is no upper cap on the maximum amount to invest. Hence, you can start the scheme with small regular payments and gradually increase the installment as your income flourishes. In the lump sum mode of investment, you need to have a big-ticket, that is, a disposable bulk of the amount at hand. You can accumulate a substantial amount only if you have a handsome income or have saved for a long time. But, you can invest via SIPs even if you have not saved much or have a manageable salary.
2. A Habit of Regular Investments
Investments through SIPs develop a habit of regularly saving and investing it in a fund scheme. Thus, they inculcate a sense of financial discipline in life. You can save a small amount of money to contribute regularly. It is better if you automate the SIP deduction from your account. When you set the date for SIP installment earlier in the month, a part of your salary will go to mutual fund investments before you spend it on other expenses. Thereby, without compromising much on your lifestyle, you can keep your investments going on simultaneously.
3. Build Corpus
The benefit of mutual funds is that they help in wealth generation and one can create a diverse portfolio with a perfect blend of return-giving and stability-providing funds. With SIPs, investors can keep adding more units of a scheme that will yield high returns in the long run. Generally, they are suitable for long-duration growth-oriented funds where small amounts of money will help to build capital over time.
4. Power of Compounding
This is one of the major advantages of SIPs, especially in comparison to the lump sum investment in a mutual fund scheme. With SIPs, the returns generated from the purchase of units are reinvested to buy more units of the scheme. Thus, the new returns are calculated at the units purchased from the regular installments plus the reinvested previous returns, giving a compounded return. This is the power of compounding of the SIPs that help in the creation of a huge corpus in the long term.
5. The Benefit of Rupee Cost Averaging
An advantage that SIPs draw over lump sums is that investors do not buy the units of a fund scheme at once and this averages out the total cost. For instance, compare two situations- first, if you buy the units at once through a lump sum investment of Rs. 60,000 and second, if you spread this amount through monthly SIPs of Rs. 1,000 for 5 years. SIPs lead you to purchase fund units throughout the investment horizon that undergo different market cycles, unlike the lump-sum purchase. You buy more units of a fund scheme when the costs, that is, the per-unit value of the units are high. Similarly, you buy less when the NAV is down. Units purchased during the market lows compensate for the ones bought during market highs. This helps to tide over fluctuations and even out the cost.
This mechanism is known as the Rupee Cost Averaging (RCA) that the SIPs proffer. Over time, the purchase cost of fund units turns out to be averaged out vis-a-vis the lump sum investment in a fund.
6. SIPs offer Flexibility
In a SIP, you may miss an installment as well as increase or decrease the installment amount. Likewise, you can stop the Systematic Investment Plan of an open-ended fund at any time without paying a fine. Some funds do have an Exit Load that charges you for stopping the SIP untimely. You pay a small percentage of the fund returns if you withdraw the units before the predetermined time duration. But, this is not the case with open-ended SIPs. You do not pay any fine for skipping the installments or stopping the SIP. You even pay a fine if you miss the payment or have premature withdrawal of Fixed/Recurring Deposits. They also facilitate the partial and complete withdrawal of the money from the fund that you gain as returns. You can redeem the units partially/wholly while you continue the SIP for the fund.
Why Opt for SIPs – Benefits
The features stated above give ample reasons as to why investors should consider SIPs as a favorable investment avenue to park their money and generate returns on it. It is especially beneficial for small and medium-sized investors who want to save and invest with minimal risks and maximum returns. You should invest in SIPs because:
- SIPs have emerged as a veritable model of investment. This is because it is an ideal choice for young and new investors. You need not have a substantial investible surplus like a lump sum investment. Moreover, it imparts a discipline of regular savings/investments
- It is less stressful as you can invest in small amounts. You also need not wrestle with market mood and index levels. Additionally, SIPs average out the costs and beat the volatility by staggering the investment amount throughout the investment cycle and the compounding effect
- It is convenient as SIPs can be paid through activation of the auto-transfer mode of money from the bank account. You can either give the standing instructions to the bank or activate automatic ECS. ECS stands for Electronic Clearing System which is an electronic mode of fund transfer
- It saves you from emotional, inconsistent, or any kind of ad hoc investment due to any timing bias of the markets. SIPs allow investors to invest through all market phases and evenly distribute the risks and the costs. Well-qualified and experienced fund managers track the performance of the Systematic Investment Plans. You need not regularly find time to check the market moods for periodic investments. Also, you need not worry about the right time to invest or postpone the payment if trends are not optimistic. You are free from all such predicaments
Who Should Invest?
The investment goals of the investors and the mutual fund schemes must align together. So, if you want to invest a lump sum for short-term goals then you should consider debt funds. It is also an alternative to Fixed Deposits (FDs) or Recurring Deposits (RDs). Debt mutual funds can offer better returns than bank deposits. SIPs are not very advisable for short-term debt fund schemes. But, if you wish to stay invested for the long term to earn interests and build a corpus, then go for equity funds and opt for SIPs (Systematic Investment Plans). Therefore, SIPs are suitable for:
- Investors with a long term investment horizon of a minimum of 5-7 years (can up to 10-15 years or more)
- The investors that seek capital appreciation and have the moderate risk tolerance
- Many investors cannot invest through lumpsum as they do not have so much money in bulk and may not be able to accumulate it in the near future. SIPs are helpful to invest in small amounts
- SIPs help to distribute risk as you invest through different cycles of the market. A lump sum investment during market lows may generate high returns when trends change. But if markets continue to fall, investors will suffer a loss. Investors who cannot identify the cycles and do not want the investment decisions to be clouded with any emotional biases should opt for SIPs
Wrapping it up:
One of the biggest misconceptions is that SIPs are an additional investment type other than mutual funds whereas they are not. They are also not a synonym for mutual funds but a tool to invest in fund schemes through periodic installments. SIPs give compounding effects to generate wealth through systematic investment on a long-term basis. Moreover, SIPs spread the investment throughout the market cycle averaging out the purchase cost of units. One-time payment does not take into account the market downturns like the SIPs do. If you have a cash surplus from a bonus or property sale, then you may invest through a lump sum. However, SIPs can help young earners to invest in small amounts. Lump sums are also better suited for liquid or income funds. Whereas, SIPs are advantageous in the case of long-term equity funds as they are best suited for widely fluctuating markets.