“SIP is deliberately doing something slightly inferior, to prevent the likelihood of something very inferior. It’s such a fine line between stupid and clear. SIP seems clever, but we should recognize it’s true value lies in not being stupid.” –Tim Harford, Financial Times, October 2018
What is a systematic investment plan?
A systematic investment plan (SIP) is a way to invest in mutual funds. A SIP is equivalent to a recurring deposit in mutual funds. It allows an investor to invest a fixed amount in mutual funds at regular intervals. The frequency could be weekly, monthly, quarterly, half-yearly, or annually. For most salaried investors, a monthly SIP works well as this matches their cash inflows.
How does SIP work?
To understand how a SIP works, let’s look at:
- How to start a SIP
- What happens when you miss an installment?
- Where your money goes
- How to stop a SIP
How to start a SIP:
A SIP is similar to an automatic bill payment (electricity, gas, etc.). You could set up a standing instruction with your bank to debit a fixed amount to be invested in a specific mutual fund scheme. This instruction can be set for a fixed number of installments on specified dates within a month.
What happens when you miss an installment?
A SIP debit may not occur if there is insufficient balance in the account. Unlike a recurring deposit, there is no penalty from the mutual fund for missing a SIP installment. A SIP is automatically canceled when you miss three consecutive installments. If you miss an installment and want to catch up you could always make up by doing an unscheduled one-time investment.
Where does your money go?
Once the SIP is debited from your bank account, the money is transferred to the mutual fund scheme. Every mutual fund scheme has a fund manager and a unique mandate. The mandate defines what instruments (debt, equity, gold, etc.) that the fund can invest in. The mutual fund manager then deploys cash into investment avenues according to the mandate.
How to stop a SIP?
A SIP automatically expires after the fixed number of installments. If you wish to stop a SIP before this term, you could submit a stop SIP form. These forms usually take around 30 days to be processed. So, it’s better to plan your exit from a SIP at least one month in advance.
Why should you invest in SIP?
A SIP is a simple but effective way to save. It allows you to channel your savings regularly into different asset classes like equity, debt, gold, or real estate in a disciplined way. A SIP is also hassle-free – once you set the automatic debit, you needn’t worry about your savings plan. SIPs are also versatile – a young working professional could start a SIP for a few thousand rupees. Someone well into their careers could do SIPs for a few lakhs. The underlying concept is independent of how much is being invested.
Other Benefits of Systematic Investment Plan
Rupee Cost Averaging
Mutual funds are market-linked products. This means that their value changes every day. Investors are often tempted to buy at the lowest prices and tend to time the markets. Catching the bottom is next to impossible. What is easier to achieve is averaging costs – this is exactly what a SIP does. For instance, let’s take the example of Ranjit who saves Rs. 5,000 in mutual funds. He averages costs through a SIP.
This data is for illustrative purposes only and does not correspond to actual NAV movements.
When the markets are down, Ranjit is allotted more units and when the market goes up, he’s allotted fewer units. This allows him to average his cost per unit of Mutual funds. His average cost per unit is roughly Rs. 20 in this example.
Discipline is the key to wealth creation. A SIP allows you to invest systematically, consistently, and automatically. It inculcates financial discipline and ensures that you stay invested for the long term. A monthly SIP is a salaried person’s best investment tool. A quarterly or semi-annual SIP could work better for those who are self-employed or entrepreneurs.
Power of Compounding
The power of compounding is more pronounced with time. Let’s watch how Ranjit’s SIP of Rs. 5,000 grows over time:
Mutual funds are the only instruments that allow retail investors to invest in asset classes. Asset allocation is a cornerstone of wealth creation and financial stability. You could structure your SIPs to invest across asset classes through market cycles with professional guidance.