What is SIP and How Does SIP Investment Work?
Investments have become an integral part of financial planning. Initially it was only savings, but now the quest to earn higher returns have led to investment. SIP is one such way of investment which has been largely opted by investors.
Systematic Investment Plan (SIP) is a disciplined investment approach that helps in building greater wealth for future by investing a pre-determined sum at regular intervals (weekly, monthly, quarterly, etc.) You can also choose the option of auto-debit by instructing the bank to periodically withdraw the amount and direct the investment towards your chosen mutual fund scheme.
As SIPs are flexible in nature, investors can anytime increase their investment amount and also discontinue their investment.
How SIPs work?
SIPs work like recurring investments, where this amount is auto-debited from your bank account and invested in the mutual fund of your choice. Once the amount is deposited, you get a certain number of units of the mutual fund scheme where you have invested. The number of units that you have invested depends upon the Net Asset Value (NAV) of that particular scheme for that particular day.
SIP allots you additional units of the scheme with every instalment. As the NAV of the scheme keeps on changing, with the same SIP amount you may buy fewer units when the market is high and more units when the market is low.
So, why is SIP an ideal investment option? There are two underlying processes to understand the work of SIP.
Power of compounding
Unlike simple interest where the interest is calculated on the base capital, in case of compounding, interest is calculated on the newly increased capital after the interest is added to the base capital. So in case of compounding, your money grows exponentially. For instance, if you deposit Rs 100 for a tenure of 5 years with interest of 10%, the amount in case of simple interest will be Rs 150; while in case of compound interest, it will be Rs 161. So, power of compounding gives a rise of 7%.
This amount staggeringly increases when the term increases. For instance, the same amount with the same rate of interest when is invested for 20 years, the compounded amount becomes Rs 673 while in case of simple interest, the amount becomes Rs 300.
Rupee Cost Averaging
This is another advantage of SIP in which a person buys more units when the market is low and buys fewer units when the market is high. Here is an illustration which explains rupee cost averaging; we consider two situations of investment in mutual funds one through SIP and another through lump sum.
|Month||NAV||SIP investment (Rs)||No. of units||Average cost per unit (Rs)||Lump sum investment (Rs)||No. of units||Average cost per unit (Rs)|
Over a period of 6 months, the investment through SIP gets more units i.e. 300 with per unit cost at Rs 12. Similarly, with a lump sum investment, one gets only 240 units with per unit cost as high as Rs 15.
Features of SIP
Systematic Investment Plan (SIP) is a flexible investment strategy that allows individuals to invest in Mutual Funds with several advantageous features:
1. Modest investment plan: SIP is an ideal option for those interested in starting an investment with a relatively small amount, in contrast to substantial lumpsum investments. SIP allows you to commence with as little as Rs 500 per month and allows for gradual increases as your income grows.
2. Consistent investment intervals: SIP promotes a disciplined approach to saving and investing by allowing you to choose from various investment intervals such as weekly, monthly or quarterly. This regular investment pattern facilitates rupee cost averaging and assists in building a systematic investment habit.
3. Fixed investment amount: When you start a SIP, the investment amount is fixed. While you can use the ‘SIP Top-up’ feature to make supplementary contributions, it is important to note that you cannot reduce the SIP amount without discontinuing the existing plan and creating a new one.
4. Investment pause option: SIP offers the flexibility to temporarily suspend your investments for one to three months, which can be particularly valuable during financial hardships. The SIP resumes automatically upon the conclusion of the pause period. It is advisable to consult with your Mutual Fund provider to confirm the availability of this pause facility.
5. Adjustable SIP intervals: SIP grants you the convenience of altering your investment intervals between weekly, monthly or quarterly SIPs. You can initiate this change through an online request or by submitting a written request to your respective Mutual Fund provider.
6. No maximum investment limit: While the minimum SIP investment is Rs 500, no stringent upper limit exists. This allows investors to invest any sum they choose through the SIP. It is crucial to maintain the consistency of your SIP investments for the duration of the plan.
7. Cancellation provision: SIP provides the flexibility to terminate the plan at any time. Cancellation can be done online or by providing the SIP cancellation form to the relevant Mutual Fund provider. Additionally, you can remove the Asset Management Company (AMC) as a biller from your bank account to halt SIP payments
Benefits of investing in SIP
Investing in a Systematic Investment Plan (SIP) is a wise choice with many advantages for those seeking to participate in Mutual Funds in a systematic and organised manner.
Disciplined investment: SIP promotes disciplined investing by requiring regular contributions of a fixed amount. This approach encourages individuals to avoid attempting to predict the unpredictable nature of the market. It enables a consistent, reliable habit of saving and investing, a fundamental element in long-term wealth accumulation.
Cost efficiency: SIP makes Mutual Fund investment accessible to a broad spectrum of investors owing to its low minimum investment threshold. Moreover, breaking the investment into smaller, regular portions helps in reducing the influence of market fluctuations. Costs associated with investing in Mutual Funds through SIP are also relatively lower than those of alternative methods.
Power of compounding: SIP harnesses the power of compounding. Regular contributions over an extended timeframe allow not only the initial investment to grow but also the generated returns. This compounding effect leads to significantly higher returns on investment.
Flexibility: SIP allows investors to start, pause, increase or decrease their investments, aligning their strategies with evolving financial objectives and circumstances.
Diversification: SIP enables access to a diversified portfolio of assets, given that Mutual Funds typically invest in various securities such as stocks, bonds and diverse instruments. This diversification effectively spreads investment risk, reducing vulnerability to market volatility.
The entire process of SIP can be beneficial only when a person starts investing early and parks the money in the market for a longer period. One can start low and increase investments in the long run to enjoy the benefits of compounding. SIP investment calculator helps you to calculate your returns on your systematic investment. Start investing in your preferred fund through SIP to fulfil your long dreamt financial goals.
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