Many individuals assume that investing in mutual funds requires a high-risk appetite and a huge initial investment. Hence, they prefer investing in traditional investment instruments that are incapable of generating inflation-adjusted returns and are thus unable to create an adequate corpus for their financial goals. Mutual funds offer several variants that one can choose from based on their risk appetite, investment horizon, and investment objective. Now coming to the second assumption about the initial investment, mutual fund investments do not require a huge initial investment. You can start your mutual fund investment journey with as low as Rs 500. This is possible with a Systematic Investment Plan (SIP), which is a mode to gradually invest in mutual funds. This article explains what SIP is and the benefits of investing in mutual fund SIPs.
What is SIP?
A Systematic Investment Plan, popularly known as SIP, is an investment route offered by mutual funds wherein an investor can gradually invest a fixed amount in a mutual fund scheme of his/her choice at regular intervals.
So, the SIP instalment could be as low as Rs 500 a month and is similar to a Bank Recurring Deposit (RD). It is convenient as you can gradually invest in mutual funds by giving a standing instruction/debit mandate to your bank to debit the mentioned amount every month. Once you give a standing instruction to the bank, the specified amount gets deducted from your Savings Bank Account on a specified date and is invested in the selected mutual fund scheme in a steady manner. Depending upon the scheme, some fund houses offer SIP frequency of weekly, monthly, quarterly, half-yearly, etc. Amongst these, the monthly SIP is the most popular type. Since SIP allows you to invest a small amount periodically, you do not need to have a substantial amount to start investing in mutual funds.
What are the key benefits of SIPs?
Here are the 5 key benefits of investing in mutual funds through SIPs:
1. Does Not Require Huge Initial Investment:
SIP allows you to start your mutual fund investment even with limited earnings. You can start investing through SIP with just Rs 500 every month. This is an affordable way to invest for your goals when you lack a lump sum amount to invest or have limited earnings. Furthermore, it also allows you to increase your SIP contribution at your convenience. So, if there is a rise in your income or you manage to save more, you can choose to increase your SIP instalment by opting for a Top-up SIP, also known as Step-up SIP.
2. Power of Compounding:
The returns you fetch on your accrued returns are referred to as compounding of returns. These returns are calculated using the XIRR method, and it can help small investors grow and accumulate decent wealth in the long run.
To get the maximum benefit from the power of compounding, you need to start investing early so that you have more years in hand to compound your wealth. You can calculate the compounded returns through SIP with the help of sophisticated and easy-to-use SIP calculators available on several financial websites.
Here’s an example of how the power of compounding can help you build a corpus over the years:
Monthly SIP instalment: Rs 25,000
Investment horizon: 15 years
Expected rate of returns: 12% p.a.
|Total SIP Investment
(Source: PersonalFN Research)
The above table is for illustration purpose only.
3. Rupee Cost Averaging:
When you invest in equity mutual funds via SIP, you invest a fixed amount regularly across different market levels without having to time the market. Meaning you do not have to worry about the market cycles and whether the time is right for investment. It lets you buy more units when the market swings downwards and lesser units when it rises.
SIPs help you average out the purchase price of the equity fund units over time, thus lessening the impact of short-term market fluctuations on your investments. During extreme market volatility, you benefit from the rupee cost averaging and can earn higher returns as the market recovers.
4. Flexibility to Invest at your convenience:
Through SIP, you can start a mutual fund investment with just Rs 500 a month and choose the SIP date at your convenience. If you are a salaried individual, selecting a SIP date at the beginning of the month makes sense as you will have a sufficient amount in your bank account for SIP deduction, and the SIP instalment will not bounce. You can also choose weekly, quarterly or half-yearly frequency for SIP deduction, depending upon the fund you want to invest into. Furthermore, some mutual fund houses offer Smart SIPs that allow you to vary your SIP contribution based on the movement of pre-critera, such as Index Level, P/E Ratio, etc. Since SIP helps invest in a disciplined and phased manner, it infuses financial discipline into the investors in the long run.
5. Higher Returns:
Mutual fund schemes are professionally managed by fund managers who are experts with proven track records. They consistently work toward generating optimum returns from the investment with the help of their team of qualified research analysts. By investing a small amount via SIP regularly, You can reap significant returns in the long term with the help of professional management. SIP in carefully selected equity mutual funds can generate substantially higher returns than conventional investment avenues like Recurring Deposits, PPFs, etc., which can help you achieve your long-term financial goals sooner. Furthermore, you can claim tax deduction of upto Rs 1.5 lakhs under Section 80C of the Income Tax Act, 1961, by investing in tax-saving SIPs or Equity-Linked Saving Scheme (ELSS).
While some entities advertise SIPs as a Safe Investment Plan that eliminates the market risk and help you achieve your target by generating above-average returns, remember that SIP is certainly not free from market risk. As discussed earlier, SIP is just a route of steadily investing in mutual funds and not a separate investment avenue. So, when the market is showing a bearish trend, even if you buy units at a lower cost, they will eventually be valued at an even lower cost if the market moves downwards. Similarly, during a sideway market, SIP will have limited benefit from the rupee cost averaging, and the maturity value will be closer to the average cost. Hence, SIPs might not generate significant returns when the market is moving sideways. This is why it is imperative to choose suitable mutual fund schemes for SIPs after considering your investment profile. Depending on your risk appetite and return expectations, you can choose to invest in suitable equity or debt-oriented fund.
With the several benefits that SIP offers, it proves to be a rewarding strategy to generate inflation-beating returns and create an adequate corpus to achieve your long-term financial goals. However, before selecting the mutual fund scheme, you should ensure that the scheme’s investment objective aligns with your financial goal, risk appetite, and investment horizon. Since the SIP investment carries market risk, it is crucial to follow financial discipline and rebalance the portfolio periodically.
SIP has made life easy –it’s lighter on the wallet, you don’t need to time the market to generate wealth, infuses the habit of investing regularly, and is an effective medium to accomplish vital financial goals.
This article first appeared on PersonalFN here