SIP investments in mutual funds are more than what meets the eye.So, let us take a holistic view of investing in equity mutual funds via SIP.
Investing in Capital Markets, especially the equity instrument is very volatile. The investment is all the more risky if it is for a short tenure. Investment in the capital market turns out profitable if it is done for a medium or longer tenure i.e. at least for 5 years to 7 years.
Traditional wisdom says that the Systematic Investment Plan or SIP is a better route of investing in equity mutual funds to achieve your desired financial goal. Let us study about investing correctly for achieving financial goals.
What is SIP?
Systematic Investment Plan, commonly known as SIP, is one of the most popular wealth creation instruments. With SIP, an investor can invest a pre-determined amount regularly in the mutual fund scheme, just like an RD. However, the biggest difference is that SIPs invests your money in a mutual fund scheme, unlike RD which invests money in a bank deposit. Even though investing in mutual fund schemes through SIPs are prone to market risk, it is still a preferred investment tool for the following reasons:
- Rupee cost averaging benefit
- Imparts financial discipline
- Allows investing at regular intervals (weekly, monthly, quarterly, etc) without worrying about the market movement.
- Hassle-free transaction as the money gets invested in the specified mutual fund scheme automatically
How does SIP work?
SIP helps the investor to build wealth overtime by investing in the mutual fund scheme regularly. Investing in a mutual fund scheme with SIP is very simple. SIP works in the following manner:
- Select the mutual fund scheme according to your risk profile and asset allocation
- Choose the amount you want to invest at regular intervals and number of years for which investment is to be done
- At the pre-determined interval investors,the money would be automatically debited from the bank account
- This amount will be invested in the pre-determined mutual fund scheme, as per your choice
- Once the amount is invested, the investor shall be allotted certain units as per the ‘Net Asset Value’ of the fund
- Every time money is invested in the scheme, units shall be added to the investor’s account as per the NAV of the fund
Kindly note, these units are allotted to the investor as per current market conditions, so the rate shall vary at every purchase time.
Benefits of SIP
The most prominent benefits of investing by the SIP route are Rupee Cost Averaging and the Power of Compounding.
- Rupee Cost Averaging: This refers to averaging the cost incurred for the purchase of units in a mutual fund scheme. This method helps in overcoming the volatility of the stock market. The rupee cost averaging refers to buying more units of a mutual fund when the stock market is low and buying fewer units when the stock market is high.
- Power of Compounding: The power of compounding offers higher returns when an investment is made for a longer tenure. When you invest money, you earn a certain percentage as interest. Under compounding, the interest earned is added back to the principal amount and is invested as principal for the next year.
In the case of equity mutual funds through SIP, there is no “interest” earned, but the returns are on the entire fund value. So, the power of compounding works here as well. For example, if you have invested Rs. 10,000 in an investment earning 10% returns,at the end of the first year, your fund value will be Rs 1000.
Now, the power of compounding comes in play. The returns for year 2 is on the entire amount of Rs. 11, 000 instead of Rs. 10,000. So, next year, if the returns are again 10%, then it would Rs. 1100 on Rs. 11,000 and by the end of year 2, the total fund value would become Rs. 12,100. The power of compounding will come into effect when the investment is kept for a longer duration as the principal amount will keep on increasing and so shall the interest component increase.
Investing in the equity market via SIP for a 5 year goal
Investing in the equity market can be done in two ways namely – SIP or Lump-sum Investment. Both the investing methodologies are best while investing in equity mutual funds for a longer tenure. However, the investment approach is different, let us first understand the investing approach.
We have already seen how SIP works. Lump sum investment is different as it invests an entire amount at once in a particular equity mutual fund scheme. Lump sum investment strategies are profitable if they are done by a highly skilled and educated investor. For lump-sum investment,a better understanding of the stock market and its behaviour is important.
Both of these investment strategies are useful for attaining goal-based financial planning as they complement each other. However, the best investment strategy is to combine both the strategies i.e. lump-sum investment and SIP investing, when the stock market is under-performing.
However, if you are aiming for a five-year investment goal, then opting for the right mutual fund scheme is also important. The stock market offers various mutual fund schemes to invest money like equity mutual fund or debt fund scheme. However, the resultant of both the schemes shall be different as the performance of the schemes is different.
A debt fund scheme is less risky and offers a steady return on investment. The returns offered by debt funds are slightly higher or similar to the returns offered by traditional investment tools like Fixed Deposit Receipt or Recurring Deposit. On the other hand, the equity mutual fund scheme offers higher returns, but is riskier as compared to the debt mutual fund scheme. Of course, return on investment or how much returns you will earn on your investments is an important factor. While it depends on the market conditions across the long run, the power of compounding and rupee cost averaging saves your day.
There are a few important factors to consider while investing in SIP are as under:
- It is important to understand that SIP is a wonderful investment option for small investors and it gives wonderful returns in the long-run.
- The fundamental factor of investing in SIP for goal-based financial planning works best only if the investment is made in right SIP and of right SIP amount.
- Investing in SIP is advantageous and helps you in achieving the desired financial goal if the investment is done systematically by choosing the right mutual fund scheme, the right investment strategy and the right amount.
Recommended Read: How Should a Newcomer Invest in Mutual Funds?