What is a Systematic Investment Plan or SIP? How does it work?

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What is SIP?

How does it work?

I used to interact with many people across different layers of society who comes to us for personal financial advice. It’s a question that remains central in the interaction.

I want to provide an answer for this question through this page, as how does SIP work and much more, practical ways to understand it.

People often get confused while investing money – more because there are various financial products available in the market today. However, if you don’t want to speculate and want good returns, then mutual funds may be a good option for you.

Although there are many ways to invest in mutual funds, but Systematic Investment Plan (SIP) is one of the best ways of entering into mutual funds, where one can do a small amount of investment every month in a scheme of one’s choice.

A Systematic Investment Plan or SIP is a plan where a small amount is invested in the market on a monthly or quarterly basis. It is a smart and hassle free mode for investing money in mutual funds.

SIP allows you to invest a certain pre-determined amount at a regular interval (Weekly, Monthly, Quarterly, etc.). A SIP is a planned method towards investments and helps you inculcate the habit of saving, achieving your financial goals and building wealth for the future.

It is conceptually similar to a Recurring Deposit (Bank RD or Postal RD) whereby a fixed investment is made on a regular basis. It derives its name from the fact that it is a systematic approach to managing your investment.

It can also be viewed as kind of regular installments that go towards investment. The SIP amount, an investor set aside, depends on his/her particular needs and financial goals.

How does it work?

A SIP is a flexible and easy investment plan. Your money is auto-debited thru National Automated Clearing House (NACH) or ECS (Electronic Clearing Service) from your bank account and invested into a specific mutual fund scheme.

You are allocated certain number of units based on the ongoing market rate (called NAV or Net Asset Value) for the day.

If registered, you would receive SMS and Email from the invested mutual fund scheme every month or quarter etc.

Every time you invest money, additional units of the scheme are purchased at the market rate and added to your account. Hence, units are bought at different rates and investors benefit from Rupee-Cost Averaging and the Power of Compounding.

Rupee-Cost Averaging

An SIP means you commit yourself to investing a fixed amount every month.

Let’s say it is Rs. 1000/-. When the market price of shares fall, the investor benefits by purchasing more units; and is protected by-purchasing less when the price rises. Thus the average cost of units is always closer to the lower end making the investment profitable.

The illustration below explains the benefit of an SIP over a lump sum.

Hence, at the end of the period total units purchased will be 257.263 & cost per unit will be Rs. 46.645/-. Thus, the profit from the above investment will amount to Rs. 1,378/- (Rs. 13,378 – Rs. 12,000)

A SIP investor, while investing every month would end up buying MORE UNITS when markets go down and buying LESS UNITS when market goes up.

The above is for illustration purpose only. The SIP amount, tenure of SIP, expected rate of return are assumed figures for the purpose of explaining the concept of advantages of SIP investments. The actual result may vary from depicted results depending on scheme selected. It should not be construed to be indicative of scheme performance in any manner. Past performance may or may not be sustained in future.

Power of Compounding

Estimated returns from SIP into an Equity Mutual Fund (at an assumed rate of 12% p.a.)

Hence, one should know that it is not the magic but the power of compounding which helped you gain a profit of almost Rs 1.58 Crore (assuming a rate of return of 12% per annum).

When we look at the corpus accumulated at the end of the tenor, the wealth accumulation is at its best in the long run investment. As the time given to investment increases, the wealth builds at an accelerated pace because of compounding outcome.

Illustration disclaimer: The above example is only for illustration purposes & shall not be construed as indicative yields or returns of any of the Schemes.

As per my opinion “The best way to plan for SIP is to plan for a financial goal and the total amount you need to achieve at a given period of time. Any investment you do should always have a purpose attached to it.”

This helps you in doing dedicated savings, else you will always remain with a dilemma whether to invest or to stop the current investments or redeem money as per the market conditions at any point in time.

[blockquote style=”1″]“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” – Albert Einstein[/blockquote]

Advantages of SIP

Start small and increase as your income grows

Reap benefits of starting early

Systematic and disciplined investment approach

No need to time the market

Harness the power of two powerful investment strategies

Saves you time – By opting for NACH, you drive handsfree. You can go to your own business while your money takes care of itself.

Rupee Cost Averaging – that lets you benefit from volatility

Power of compounding – small investments create large fund over time

Combine the benefits of tax-saving with systematic investing

Keep in Mind

Start early, earn bigger returns

Stay longer, enjoy the compounding effect

Be patient, the money is sure to grow in the long run

Be consistent, never skip your monthly payment

Disclaimer: Mutual fund investments are subject to market risks, read all scheme related documents carefully.

 

I am a CERTIFIED FINANCIAL PLANNERCM. For the moment, I have shared my experience growing up with you because it had a tremendous impact on how I do what I do.

If you have a question about your own financial situation please connect with me.  I’d be delighted to try to be of service.

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