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Systematic Investment Plan (SIP) | Meaning, Benefits and How it works ?

Last Updated : 13 Dec, 2023
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What is SIP (Systematic Investment Plan) ?

Systematic Investment Plan, commonly known as SIP is an investing channel initiated by Mutual Funds, under which one can invest a fixed amount at predetermined time intervals in Mutual Fund Scheme. Such an amount is generally invested every month, but it could be invested once a week, once in a quarter, half-yearly, or even annually. The system of SIP can be easily understood as a recurring deposit under which a certain fixed amount is deposited on a specific date for a predetermined time period. 

The popularity of SIP among people, especially youngsters has increased in recent years as it offers an investing platform with a minimum amount of ₹500 and also promotes discipline in investing habits. SIP does not demand separate time and attention from investors as the amount is directly deducted from their bank account. Mutual Funds and Portfolio Investment further minimise the risk associated with SIP, making it a time and risk-efficient channel.

What is SIP?

How does SIP Work?

First, let’s understand the process of SIP. Once a person took a SIP plan, the amount and frequency of investment are decided as per the scheme opted. Then the money invested is used to purchase securities (say equities, Debentures, bonds, money market instruments, etc termed as ‘units’), according to the existing Net Asset Value (NAV) at that time. Such investing decisions are taken by professional fund/portfolio managers of the Mutual Funds. As SIP is recurring in nature, the number of units held by the investors increases with time and so does the value of an investment. However, SIP and Mutual Funds are subject to market risk and do not promise an increase in investment. Sometimes due to adverse market conditions investment value may go down.

*Net Asset Value (NAV) denotes the performance of a particular scheme of a Mutual Fund. NAV can be defined as the market value of all the securities (equities, bonds, money market instruments, and other securities) held by the scheme.

Secondly, understand the Principles on which SIP works:

(A) Power of Compounding: The power of compounding can make a small investment yield a significant return in long run. Under this interest earned on the principal amount is re-invested, to sum up the amount and get a maximum benefit of investment later. The investment made for longer durations yields greater returns.

(B) Rupee-cost averaging: Rupee-cost averaging is a technique used by investors to reduce the impact of market volatility on their investments. Rupee-cost averaging helps them to purchase more units of an investment when prices are low and fewer units when prices are high, this eliminates the impact of short-term fluctuations in the market and reduces the average cost of the investment. 

Features of Systematic Investment Plan

Instalment investment at regular intervals makes SIP convenient and reliable for investors, making it beneficiary even for small investors. But this is just an extract of features we know, so let’s understand key features of SIP to make it easier to understand:

1. Secured Channel of Investment: SIP is a platform offered by Mutual Funds under which investment decisions are made by professional fund managers on the behalf of their clients, making it secure and risk efficient. Even a person with zero knowledge of the stock market can rely on SIP for long-term savings and investment benefits.

2. Time and Effort Efficient: Investment in SIP needs no separate time and effort from the investors. Once a person has opted for SIP, depending upon the Mutual Fund scheme, and agrees to terms of auto-debiting, the fixed amount is directly deducted from his bank account at fixed time intervals say a week. month or quarter. This feature makes SIP easy for all age groups, especially for young people busy climbing the stairs to success. 

3. Disciplined and Organised: The most eye-catching feature of SIP is that it encourages discipline in investing habits of the investors. Investors get an addiction to saving and investing. Besides this, with each such investment, an organised detailed report is conveyed to the investors, indicating the no. of units held, information about new investments, and details of portfolio holdings along with the Net Asset Value (NAV) of the scheme.

4. Benefit of Compounding: The most promising feature of SIP is that it helps in availing the benefits of Compounding. Compounding is a method under which interest earned on the principal amount is re-invested for a higher return. The principal amount shall be kept invested along with the interest for a longer period to get a magnified earning in long run.  

5. Ease to Stop or Skip: SIP plan can be exited at any point of time at the will of the investor. Once the investor step out of the plan, it is up to him/her whether to return to the amount or to continue investing in Mutual Fund. SIP unlike recurring deposits not create a burden of paying instalments each time. This means investors can skip the payment of instalments for the next time when they have no money without actually paying any fine.

Benefits of Investing in SIP

Every investor wishes to earn a maximum return with minimum risk. Such benefits can be avail under the SIP Scheme along with other benefits:

1. Secure and Lower Risk: Under SIP investments are made under Mutual Funds Scheme where a portfolio of diversified securities is created for investment purposes. Such diversified spread the risk and benefits investors. Moreover, in SIP initial investments are of small amounts that wipe out the capital risk associated with Lump sum investments.

2. Less Hustle: SIP plans come with a feature of auto-debiting directly from the bank account of the investor, so no separate effort and time are to be invested by the investors to handle their SIP investments. Moreover, in the case of being a defaulter in paying instalments, no fine is charged which is the biggest relief for investors with temporary earnings.

3. Advantage of Compounding: SIP is based on the principle of Compounding under which the amount earned on the principal amount (interest) is also added to the investment amount that yields a high return in long run. To get the maximum benefit out of it, one shall start investing at an early age. 

4. Rupee-cost Averaging Benefit: Rupee-cost averaging helps investors to fight against the impact of market volatility on their investments and enables them to buy more units of an investment when prices are low and fewer units when prices are high, reducing the average cost of the investment.

5. Build up Discipline: SIP plans force investors to invest a fixed amount at a fixed period ultimately developing a habit of investing in a disciplined manner. Apart from this, the investors get an organised detail of the holding with the Net asset value of the units, making it easier for investors to follow up. 

6. Benefit to a Low-income Group: SIP is a platform that provides investment opportunities to people with low and uncertain incomes. The minimum amount of investment needed is as low as ₹ 500 making it possible for them to enter the investment world.

7. Tax Benefits: Investors enjoy certain deductions and exemptions by making investments under SIP. Some of them include tax deductions of up to Rs. 1.5 lakh under Section 80C, long-term capital gains tax exemption (which means any gains made on the investment after a holding period of one year are not subject to tax.), Dividend tax exemption, and so on.

SIP vs Lump sum

SIP and lump sum investments are two different approaches to investing in mutual funds. Both approaches have their own advantages and disadvantages. As an investor one can make a decision to go with either of the approaches after deciding their financial goals, risk appetite, and investment horizon. The following parameters are to consider for such decision-making:

1. Investment Frequency: If a person wants to invest the amount slowly and steadily as per convenience then SIP turns out to be the solution in this case, but on the other hand, lump-sum investment involves investing a large sum of money in one go.

2. Risk Management: SIP reduces the risk associated with market volatility as the investments under this are spread out over time. however, lump sum investments come with high market risk because of huge money involvement and the impact of market fluctuations.

3. Experience: Lump sum investment requires experience in the market and appropriate market timing to maximize the return, whereas SIP investments are suitable for a new investor with no or less market experience.

4. Flexibility: SIP investments offer greater flexibility in terms of investment amount and duration, allowing investors to increase or decrease the investment amount or pause the investment as per their financial situation. But, lump sum investments are one-time investments that offer less flexibility.

5. Returns: SIP investments generally provide higher returns over the long-term due to the power of compounding. Whereas, lump sum investments may not always provide the same level of returns as it is associated with a high risk of market fluctuations.

Although the decision to in either of the two approaches ultimately depends on investors, experts generally recommend investing through SIPs rather than a lump sum.

Factors to Consider While Starting SIP

Planning to start a SIP? Here are some important points to be considered before starting:

1. Financial Goals: Understand your vision in life to set Financial goals and then accordingly pick up the SIP plans with appropriate investment amounts that will eventually help you to accomplish your goal. You can start with a small amount and increase gradually with time.

2. Investment Horizon: Investment horizon means the span of time you are willing to stay invested. This helps in deciding the tenure of your SIP. In order to enjoy the advantages of compounding, it is often recommended to invest for a longer duration.  

3. Risk Appetite: Before getting into any SIP plan, it is important to measure the degree of risk you are willing to take and then choose a mutual fund scheme that matches your risk appetite. Equity funds are generally riskier than debt funds.

4. Investment Frequency: Investment frequency means the intervals of investment for say monthly, quarterly, or yearly. You are free to choose the investment frequency depending on your income and expenses, job security, and so on.

5. Portfolio Diversification: It is never a good idea to invest in a single fund. Always diversify your investments in different securities across different industries. Portfolio diversification spread the risk across different asset classes.

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