There are two main reasons why people stay away from investments. First is the lack of time to study the pros and cons of the investment and the second, is a lack of financial knowledge. In some cases, a large ticket size of investment could also be a steep barrier, as it precludes small investors from participating in compelling investment opportunities. Most investors’ needs can largely be divided into capital appreciation and capital protection along with capital appreciation. Mutual funds emerged as a popular investment vehicle in India because they fulfill the myriad needs of investors and provide portfolio diversification through an extensive investment product offering. One can either opt to invest lump sum money into mutual funds or one can invest through a systematic investment plan (SIP).
An SIP entails investing a fixed amount of money at regular intervals. Investments can be done on a daily, monthly or quarterly basis on a fixed date while the amount can be as little as INR 100. An SIP gives an investor the flexibility of investment, provides the investor with the desired asset class exposure and inculcates discipline.
A mathematical concept often bandied about in investment circles, the power of compounding has earned its place under the sun. The compounding effect ensures that an investment earns interest not only the principal amount invested but also on the interest earned on the investment. For example: Rs. 1000 invested at 10% per annum will earn Rs. 100 as interest at the end of year 1. Now, in the second year, both the principal amount that is, Rs. 1000 and the interest earned in the previous year, Rs. 100, will earn interest at the rate of 10%. Consequently, interest earned in year 2 will by Rs. 1100X10%= Rs. 110. The compounding effect continues through the life of the investment, thereby helping investors multiply their earnings.
Investing a fixed amount of money at regular intervals ensures that you buy more units of a scheme when prices are low and fewer units when prices are high. This is called rupee cost averaging. By averaging the purchase price, the portfolio is protected from wide market swings. It also frees the investor from the tension of trying to time the market or predicting the direction of the market.
Through an SIP, one can start investing from a mere Rs. 100. An SIP also offers the flexibility of choosing the period and interval for investment. For example, one can choose to invest daily, fortnightly, monthly and quarterly. Also, you can invest in multiple asset classes and schemes with varying amounts, without any restrictions.
An SIP can be started offline, as well as, online. Through an e-mandate, the SIP amount will automatically be deducted from your bank account on the pre-specified date. Even if your bank account does not have sufficient funds for a period or two, the SIP won’t get cancelled and it will deduct the funds once the bank account has the sufficient amount. However, in most cases, the SIP will get cancelled if the investor defaults for more than three consecutive months.
An SIP can help inculcate disciple and encourage you to develop a regular savings habit because it requires periodic investments. It is important to set an SIP deduction date such that you first invest and then spend.
In India, the SIP route can be very fruitful for the lower middle to middle class primarily because of the above-stated advantages. An SIP is also helpful for the stability of financial markets as the maximum benefit of an SIP can be derived by staying invested for the long-term.