This is how SIPs compound your investments!

What Is SIP Investment & How SIP Works?

Picture yourself planting seeds and envision a well grown tree 10 years from now. The tree would yield fruits and provide shade to the investor. Investing through SIP works the same way. You invest small amounts consistently in a mutual fund scheme in a disciplined manner. Consecutively, you accumulate wealth in 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 approximately 7.13 crore SIP accounts have been opened, hitherto. As of September 30, 2023, the total amount collected through SIPs stood at Rs 16,042 crore. However, many investors are still unaware of investing in mutual funds through SIP. Let us understand what SIP is? How it works? How should you invest in it? And the wide range of benefits it offers to the investors.

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 lump sum investments. 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 good amount of wealth over the long term. Additionally, SIP also has variants other than regular SIP. Some of these variants are Step Up SIP, Flexi SIP, Perpetual SIP, Trigger SIP etc.

How SIP works?

Let us understand how SIP works 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 Rs12,00,000. He earned 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:

1. Rupee Cost Averaging: When one buys units of a mutual fund, its price is known as Net Asset Value or NAV. The fund’s NAV that fluctuates daily. One buys more units of a mutual fund when the NAV is lower and fewer units when the NAV is higher. In other words, during market downturns, one acquires more units, while fewer units are acquired during upswings. This averages the overall cost of purchasing the units of a mutual fund. It helps one get less impacted by short-term market fluctuations.

2. 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. This paves the way for the systematic accumulation of money that results in exponential growth over time.

3. Starting Early: Historical data suggests that no matter at what frequency the SIP is made; one must start the SIP early and stay invested for a longer duration to achieve the benefits of compounding.

4. Investing Regularly: If you regularly invest even small amounts via SIP, it can help you accumulate a significant corpus due to the compounding effect. Additionally, this approach also helps you to  inculcate the habit of disciplined investing.

Advantages of Investing through SIP:

1. 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 on which money will be debited from the bank account on regular basis and tenure of the investment. These factors will off-course depend upon the risk appetite and financial goal of the investor. 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 SIP’. One can use this option to increase the amount in line with one’s income growth and at the same time one can halt it if need arises.

2. 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 (Proof of Identity, Proof of Address, PAN Card and investors’ bank account details) are ready. It is important to conduct KYC (either online or offline) and sign up for the NACH (National Automated Clearing House) mandate. Once all this is set up, SIP will automatically get deducted from the investor’s bank account on the chosen date.

3. No need to time the market: SIP allows one to invest a fixed amount regularly across different market levels without having the need to time the market. This means that the investor does not need to worry about market cycles. He doesn’t need to check whether the time is right to invest or not. Additionally, due to cost averaging factor, short-term market fluctuations will have less impact on the investments.

4. 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.

5. 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 those online.

Alternative Investment Strategies:

In addition to SIP, alternative investment methods like SWP (Systematic Withdrawal Plan) and STP (Systematic Transfer Plan) can be explored. Each of these brings unique benefits to investors. SWP, for instance, is well-suited for generation of 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 it is highly recommended that the investor consults with a financial expert before making any decision. 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.