Why should we invest in Systematic Investment Plans (SIP)?

by Vivek Bajaj on Basic Finance

— 7 mins read—

Systematic Investment Plans (SIPs) is becoming popular in the recent few years.

Thanks to demonetisation, that many individuals discovered the charm of SIP and mutual funds.

However, many investors get confused about SIPs.

Many investors think that an SIP is just an investment product.

It is important that you should have a clear understanding of the type of instrument and the market before making any investment decision for that you can join Basics of Financial Markets.

It is common to come across a query – Can I invest in an SIP to achieve my goal?

To start investing according to your financial goals, you can take help of Kredent Money App

Therefore read on to get the answers of this query:

What is Systematic Investment Plan (SIP)?

Systematic Investment Plan (SIP) is a scheme offered by the mutual funds where one can invest a sum of money at periodic intervals.

It is a well thought out and planned way of investing which helps to nurture the habit of savings and fulfil the goal of wealth generation.

In case of Sip, one can invest on a weekly, monthly or a quarterly basis as per his or her convenience.

A fixed amount is deducted from the bank account of the folio holder and is invested in mutual funds.

The number of units are allocated at the current market price which is equal to the amount invested divided by the NAV.

An investor needs to follow 4 important steps before investing in a SIP:

1) Set your financial goals
2) Decide when you will need the money
3) Decide how much you need to invest
4) Make a choice

The money can be paid by post-dated cheques or through ECS in which one gives a standing instruction to one’s bank to auto debit the investment amount from your account every month.

A sip can be perpetual or for a limited period of time.

Why Systematic Investment Plan?

Here units are bought at different rates and investors get benefit from Rupee-Cost Averaging and the Power of Compounding.

One main benefit of investing through the SIP is Rupee-Cost Averaging.

When you invest at regular intervals, your money fetches more units when the price is low and lesser when the price is high.

During volatile period, a lower average cost per unit is achieved based on the different NAV’s.

Let us see this with a small example:

DATENAVAMOUNT (RS)UNITS
7-April-1815100067
7-April-18 13100077
Total2000144

The average rate at which the investment is made is at Rs 14.

Hence units get accumulated at different market levels.

If the NAV during the end of May is Rs 17, then the value of Rs 2000 investment will be worth Rs 2,448 (144 units * Rs 17).

If a person had considered bulk investing and invested Rs 2000 on April 07, the investment will be worth only Rs 2,266 ( 2000/15 * Rs 17).

The early bird gets the worm is not just a part of the jungle folklore.

Even the “early investor” gets a lion’s share of the investment booty vis-a-vis the investor who comes in later.

This is mainly due to the power of Compounding.

The rule for compounding is simple, the sooner you start investing, the more time your money has to grow.

For example,

If you started investing Rs 10,000 a month on your 40th birthday, in 20 years’ time you would have put aside Rs 24 lakhs.

If that investment grew by an average of 7% a year, it would be worth Rs 52.4 lakhs when you reach 60.

However, if you started investing 10 years earlier, your Rs 10,000 each month would add up to Rs 36 lakhs over 30 years.

Assuming the same average annual growth of 7%, you would have Rs 1.22 cr on your 60th birthday—more than double the amount you would have reached if you had started ten years later.

You can also calculate returns of SIP investment using our SIP Calculator.

How does SIP work?

Your money is auto-debited from your bank account and invested into a specific mutual fund scheme.

You are allocated a 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 units of the scheme are purchased at the market rate and added to your account.

How to set up an SIP?

There are 2 ways of setting up an SIP:-
a) Online
b) Offline

1) Online:

In case of online, the 1st thing to be seen is that the investor is KYC compliant. If not he has to do it with the necessary documents like identity proof, address proof and a photograph.

Now he can choose an amount and do it online. He needs to select the date on which the SIP will be deducted and choose the time period for which the SIP will take place.

Post this he will have to register the fund house as a biller on his online bank account.

Let us take the following example: –

Suppose the investor chooses DSP Mutual fund, he goes to https://invest.dspim.com/

Next there is an option wherein he can click on transact without login.Then he would click on purchase.

Here if he is KYC compliant, he needs to furnish his pan number and date of birth.

Then he needs to fill in the OTP which he gets on his mobile as well as email id. Next he would choose either an existing portfolio or create a new portfolio.

Then from the list he has to choose the scheme. Post that he needs to choose SIP option.

The amount needs to be filled up, SSSthe frequency of SIP, the 1st instalment date and the SIP tenure.

He also has an option to increase the SIP instalment every year which is known as top up SIP.

After this is done he will need to confirm the transaction.

Suggested Read: 2 Steps Checklist on starting Systematic Investment Plan (SIP)

2) Offline:

In case of offline SIP, he needs to fill up the form completely in case he does not have an existing folio.

These would be name, address, fund name, type of resident, bank details, his signature etc.

Along with this he also needs to furnish the SIP date, the frequency etc. Basically he needs to do all the paperwork.

There is an SIP topup option too wherein every 6 months or 1 year he can increase the amount of SIP.

Types of SIP

Now that we have understood the basics of SIP, there are various types of SIP’s namely: –

1) Flexible SIP:

This SIP allows one to increase or decrease the amount of investment as per the cash flow of an individual. Here one can make a bigger contribution to one’s SIP amount if he receives a bonus or an additional income. In case of liquidity crunch the individual one can skip one or more payments.

2) Top up sip:

This SIP allows one to increase his periodic contribution from time to time. One can increase the investment amount as per the increase in his income.

3) Perpetual SIP:

This is a SIP where there is no end date and the SIP continues until it is stopped.

4) Trigger SIP-

This is a SIP which will get triggered based on the NAV or the index hitting a particular level.

Suggested Read: Step Up SIP v/s Static SIP Investment

Pros and cons of setting up a SIP

The advantages of setting up a sip are as follows:

  • It reduces the risk- In case of SIP, investment is done at periodic intervals over a long period of time which helps in beating the market volatility. Moreunits are bought when the markets are down and lesser units are bought when the markets are up.

  • It provides a discipline since there is a weekly, fortnightly, monthly or quarterly investment of the same amount.

  • It is flexible in nature since an investor can time his investment as per his flow of income

  • It saves the investor of manual investment since the investment happens on an auto pilot mode.

The disadvantages of a SIP are as follows:

  • It is not suitable for people who do not have a regular source of income.

  • If the markets go up one way for a considerable amount of time, a lumpsum is better than a SIP.

  • An investment amount cannot be changed during the ups and downs in the market.

  • In case an investor fails to keep sufficient balance in his account, the amount will not be debited and it will be dishonoured. This means that the investment will not happen for that period.

Key Takeaways:

  • Systematic Investment Plan (SIP) is a scheme offered by the mutual funds where one can invest a sum of money at periodic intervals.

  • A SIP can be perpetual or for a limited period of time SIP is mainly of 4 types: Flexible SIP, Top up sip, Perpetual SIP and Trigger SIP

  • In case of SIP, investment is done at periodic intervals over a long period of time which helps in beating the market volatility.

  • It is not suitable for people who do not have a regular source of income.


Disclaimer

Elearnmarkets.com wants to remind you that all our content is created solely for the purpose of education. No strategy, stock, commodity, fund or any other security discussed here is any way a recommendation for trading or investing. Elearnmarkets.com will not be any way responsible for trading losses incurred by any individual or entity for trading with real money. Please take advise of certified financial advisers before trading or investing.

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