It is an all-weather avenue for investment that averages your cost while you reap the benefit of compounding
We often hear about SIPs in the context of mutual funds. What is a SIP?
SIP stands for Systematic Investment Plans, a systematic and disciplined way of investing in mutual funds. Under the SIP mode of investment, a fixed sum of money is debited from your bank account and invested in a mutual fund scheme of your choice. Units of the scheme get allotted to you on the day the funds are received by the mutual fund company. NAV or Net Asset Value is the market value of each unit of a mutual fund. SIPs can be started with as low as Rs 500 or as high as even Rs 1 lakh.
What are the benefits of investing through SIPs?
SIPs help you become financially disciplined through regular saving and investing. The biggest challenge in prudent investing is discipline. It is a natural tendency to keep deferring the very act of making the decision for multiple reasons – not choosing an investment or busy in a routine day job. SIP takes away these reasons through the process of automatic investment.
Further, SIPs offer the advantage of rupee cost averaging. This means you automatically buy more units when the prices are low and fewer units when the prices are high. Thus, market volatility favours SIP investments, and as markets trend higher over the longer term, the returns get magnified.
What to consider before starting SIPs?
One must be aware of his or her financial situation, like earnings and liabilities. Then, try to understand the future financial goals – the amount required and the time horizon.
For example, whether planning for a vacation next year or planning to buy a house in the next 5 years. Accordingly, the person can select a mix of asset class (debt funds versus equity funds) and the amount to be invested each month. For example, for a short duration requirement of, say, a year, equity funds should be avoided, and SIPs should be in debt funds which exhibits subdued volatility. Similarly, if planning for 5 years or more, equity can form a significant component. Many platforms help in this process, including completing transactions entirely digitally.
SIPs are a great way of building wealth—for example, an SIP of Rs 10,000 per month can yield Rs 38 lakh in 15 years, assuming an annualised return of 9 per cent per annum. Longer the period higher the benefit of SIPs due to compounding. Compounding means that the return generated on your invested amount further earns a return in the subsequent period. Thus in the above example, if the same SIP is continued for 20 years, the corpus will be Rs 67 lakh. In this case, the accumulated amount of Rs 38 lakh at the end of 15 years will keep earning return along with the additional SIP amounts.
Given that the interest rates on bank deposits are meagre and even lower than inflation, it is recommended to save as much as possible through SIPs. Moreover, long term investment in equity mutual funds through SIPs help you generate returns that beat inflation. Also, long term investment through equity mutual funds is more tax efficient. You pay a 10 per cent tax on long term capital gains (LTCG), that too if the gain is more than one lakh in a financial year.
SIPs in mutual funds versus investing directly in stock markets
Stock markets are always volatile, and the key is to ignore the fluctuations and stay focused on your long-term goals. To invest in equities directly through stock markets, you must understand the company you are investing in and how the markets function. Then you will have to constantly track the performance of the company. You will need to spend enough time researching, analysing, and monitoring your portfolio. With mutual fund SIPs, you have professionals managing your money. Furthermore, you need not time the market since your investment cost gets averaged out over a period.
The important thing, however, is that you get started on your SIP journey early in life. The longer the time horizon for SIPs, the better it is for your wealth, as compounding needs time to work on your money. However, it is never too late to start. If you have not started a SIP already, it is not too late. Start today!
The author is Founder & CEO, Nivesh.com