A Systematic Investment Plan or SIP is a free mode for investing money in mutual funds. It helps you to improve the habit of saving and building wealth for the future.SIP allows you to invest a certain pre-determined amount at a regular interval (weekly, monthly, quarterly, etc.)
How does it work?
A SIP is a flexible and easy investment plan. Your money is automatically debited from your account and it is invested into a specific mutual fund scheme.
You are allocated certain number of units based on the ongoing market rate (called NAV or net asset value) for the day. Every time you invest money, additional values are frequently added to your bank account.
For Example- SIP allows you to pay 10 periodic investments of Rs 500 each in place of a one-time investment of Rs 5,000 in an MF. Thus, you can invest in an MF(mutual fund) without altering your other financial liabilities.
Hence, units are bought at different rates and investors benefit from Rupee-Cost Averaging and the Power of Compounding.
When you invest the same amount in a fund at regular intervals over time, you buy more units when the price is lower. Thus, you would reduce your average cost per share (or per unit) over time. This strategy is called ‘rupee cost averaging’.
Power of Compounding
Investment gurus always recommend that one must start investing early in life. One of the main reasons for doing that is the benefit of compounding.
For Example– Person A started investing Rs 10,000 per year at the age of 30. Person B started investing the same amount every year at the age of 35. When they attained the age of 60 respectively, A had built a corpus of Rs 12.23 lakh while person B’s corpus was only Rs 7.89 lakh. For this example, a rate of return of 8% compounded has been assumed. So the difference of Rs 50,000 in amount invested made a difference of more than Rs 4 lakh to their end-corpus. That difference is due to the effect of compounding. The longer the (compounding) period, the higher the returns.
In India, a recurring payment can be set for SIP using Electronic Clearing Services (ECS). Some mutual funds allow tax benefits under Equity-Linked Savings Scheme. This however has a lock-in period of three years.
Other Benefits of Systematic Investment Plans
Disciplined Saving – Discipline is the key to successful investments. When you invest through SIP, you commit yourself to save regularly. Every investment is a step towards attaining your financial objectives.
Flexibility – While it is advisable to continue SIP investments with a long-term perspective, there is no compulsion. Investors can discontinue the plan at any time. One can also increase/ decrease the amount being invested.
Long-Term Gains – Due to rupee-cost averaging and the power of compounding SIPs have the potential to deliver attractive returns over a long investment horizon.
Convenience – SIP is a hassle-free mode of investment. You can issue a standing instruction to your bank to facilitate auto-debits from your bank account.
SIPs have proved to be an ideal mode of investment for retail investors who do not have the resources to pursue active investments.
- There are no entry or exit loads on SIP investments.
- Capital gains, wherever applicable, are taxed on a first-in, first-out basis.