Decoding Systematic Investment Plan: SIP

Decoding Systematic Investment Plan


SIP Meaning

A Systematic Investment Plan (SIP) is a facility that helps create a system for investors to invest in mutual funds. It is not a fund in itself, but is a method which assists investors in reaching their investment objective. The system is based on a commitment where an investor decides to invest a particular amount on a specific date, typically every month, in his chosen mutual fund(s). By setting up this facility, an investor does not need to remember to make a periodic investment; the facility does this for him.

In order to decode SIPs, it is important to look at both benefits as well as mistakes that investors can commit while availing this facility. Let’s start with a few benefits.

The superpower of SIPs

Power of compounding

SIPs help to compound the rate of return earned on an investment portfolio. It is predicated upon the period of investment: the longer the investment, the more opportunity for this benefit to show its magic. Let’s look at an illustration:

Monthly Savings Period (In Years) Corpus Without Investment Corpus (@5% returns) Corpus (@10% returns)
7,500 10 9,00,000 11,69,470 15,49,140
7,500 15 13,50,000 20,13,020 31,34,432
7,500 20 18,00,000 30,95,597 57,42,727
7,500 25 22,50,000 44,84,932 1,00,34,178
7,500 30 27,00,000 62,67,948 1,70,94,940

As can be seen from the table above, even a meagre return of 5%, earned over the course of 25 years, can nearly double an investment of Rs 22.5 lakhs to Rs 44.8 lakhs over 25 years. A more practical, yet low return of 10%, will turn this investment into a crore rupees. If the investor stays invested for five more years (for a total of 30 years), this crore would turn into Rs 1.7 crore at a 10% return. This displays the role a longer investment horizon plays in boosting the power of compounding.

Rupee cost averaging

If the power of compounding displays the potential of SIPs, rupee cost averaging forms the foundation of the mechanism. This principle says that by investing a certain amount periodically over a period of time, the cost of holding that instrument averages out. This is so because when the performance of the chosen fund is down, an investor will accumulate more units with the periodic SIP. The number of units accumulated will decline when the fund is doing well. In this manner, over a period of time, the price at which the fund has been brought will average out.

This principle also ensures that investors do not need to be worried about market movement. Since the cost will average out anyway due to the small investment buying more or less units at different times, one does not need to keep a tab on where the market is going.

A convenient way to practice discipline

An SIP is very easy to set up and manage. Investors can start it when they want and stop it whenever they desire. One can set up an SIP via a financial advisor, broker, or any other intermediary, along with the fund house whose fund he is purchasing.

But convenience is just one aspect of an SIP. It also instills investment discipline. To keep reminding oneself to invest money every month is not an exciting proposition in the busy world of today. An SIP saves investors the hassle of doing that by ensuring that their money is invested in a fund without them having to take out time every month to do that. Also, once an investor is committed to an SIP, he has to ensure to maintain the required money with his bank every month, thus ensuring that the discipline of regular investment is not broken. 

Now, that you know the SIP meaning and its benefits, below are some funds you can invest in.

Top mutual funds to start an SIP in – According to Orowealth Advisory

SIP is a great tool for wealth creation. However, using it unwisely can lead one towards unwanted results. In order to make sure that investors are using the facility, let’s look at three mistakes that investors can commit when investing via this mechanism.

With great power comes great responsibility

A poor choice of funds

In the previous section of the article, we saw the top funds in which investors can start an SIP. This point is directly related to that. A SIP is just a mechanism to help investors invest in their chosen mutual funds; it cannot choose the right funds for them. Selecting funds appropriate to one’s risk appetite, investment objective, life stage, and other factors, is crucial for an SIP to work as it is the performance of the fund which delivers results, not the SIP.

In order to make the right choice of funds, an investor should do his due diligence or approach professional advisors who can help him make the selection.

Using SIPs for a short period

Trying to gauge the benefits of SIP over a short-term is not a sound strategy. As seen in the ‘power of compounding,’ the mechanism delivers results over the long-term. Thus, by design, a short-term investment is unlikely to provide superlative returns. Some investors choose a small period to evaluate the worthiness of SIPs and, for the most part, do not get the desired results.

If an investor needs to see for himself the benefit of an SIP but does not intend for a major commitment, he can opt for a low amount instead of opting a low duration. If he can see the mechanism delivering results, he can simply increase his SIP amount. A commitment of 7 to 10 years can be expected to bolster a portfolio’s performance.

This brings us to the next mistake, which is a related point.

A low amount will hinder SIP benefits

An investor can use an SIP in a fund to see whether it works for him. However, once he is convinced, he should bump up his committed amount. Apart from choosing the right fund and staying invested for a considerable period, opting for the right amount is crucial for a SIP to deliver results.

Even after seeing the benefits of SIP, if an investor continues to invest small, the eventual returns would be muted. As we saw in the table above, a Rs 7,500 investment per month would yield a little over Rs 1 crore over a 25 year period at 10% returns. A smaller amount will significantly decrease these returns. For example, a Rs 2,500 investment per month over the same period, earning the same returns, would yield Rs 33.4 lakhs instead of a crore – just a third of what an investor could have earned. Evaluating the merits of a SIP is fine, but doing this with a low amount will underwhelm an investor.

With its benefits, a SIP can be a phenomenal tool, but only if it is used the right way. And with its potential payoffs, it is a mechanism which should be tried out by investors taking the mutual fund route to portfolio success.

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