You cannot ignore SIP, it’s literally everywhere! Thanks to some government backed investor awareness initiatives, these days you see a lot of marketing and advertising campaigns getting carried out that emphasize the importance of starting a SIP in mutual funds. If you are considering starting a SIP in mutual funds or have already invested in them, chances are that you are still confused about how SIP works and what exactly it is.
This article aims to clear all the common doubts and misconceptions that people have about SIP so that it helps make better mutual fund investment decisions.
What is a Systematic Investment Plan?
Also referred to as SIP, a Systematic Investment Plan is a process of investing your money in mutual fund schemes. People often confuse SIP as a mutual fund product itself. It is not. Investors can either make a onetime lump-sum investment in mutual funds or they can do it periodically over a certain duration through the SIP route.
For example, if you wish to invest Rs 3 lakhs in a mutual fund scheme for 2 years but do not have all the investment sum at the beginning of the investment cycle, you can start a monthly SIP of Rs. 12.500 and invest this sum for the next 24 months. Not only will you achieve the targeted corpus, but you can also earn some interest depending on how the scheme generates returns over these two years.
What are the primary features of SIP?
The two biggest highlights of starting a SIP is that investors can benefit from the power of compounding and rupee cost averaging.
Power of compounding in mutual funds refers to the process of reinvestment and the interest earned by the interest generated from the initial investment sum. When you invest in a mutual fund scheme via SIP, over a period of time you start to earn returns on your investment sum. After remaining invested for a longer duration, these returns start generating interest of their own. This is when the power of compounding comes into effect. Investors can only witness this compounding effective if they continue to invest in mutual funds via SIP for a longer duration. The compounding effect is not applicable to short term investments.
Rupee cost averaging is another unique feature that averages out the investor’s total cost of purchase. When you start a SIP in mutual funds, you invest this sum regularly. Though the SIP sum remains constant, what fluctuates is the NAV of the mutual fund. When the NAV is high, investors are allotted fewer units in quantum the SIP sum. However, when the NAV is low, with the same SIP sum investors can buy more units. This is referred to as rupee cost averaging. Since markets are volatile most of the time, investors might be able to buy more units that will not only mitigate their overall investment risk but also reduce the cost of investment and might maximize returns in the long run. That’s because markets are volatile only for a short duration and over longer periods, investors might be able to benefit when the value of their units increases.
The SIP option is best suited for anyone who does not want to expose his or her finances to the dangers of equity markets right from the beginning of the investment cycle. Also, they are completely flexible in nature. There are no cancellation charges and investors can start or stop their SIP investments at any given time. One can even refer to the SIP calculator to get a better understanding of the future value of their SIP investments.