What is a Systematic Investment Plan (SIP): A Quick Overview

“I can guarantee one thing. Those who put an investment program in place will have a lot more money when they come to retire than those who never got around to it.”

-Noel Whittaker

(Australian Financial Advisor and Author)

In an age where we’re all dealing with more work hours, inflation, and a bunch of other stress-inducing factors, financial independence (and the financial planning it requires) continues to rise to be a priority in everybody’s life. It isn’t a surprise that a larger number of people are testing the investment waters than ever before.

But an investment isn’t just the idea of putting your money into assets. It’s more a strategy than anything else to be honest – one which adds more value and brings in more wealth to whoever executes it right. This is done to achieve your financial targets as soon as possible and to secure your future.

A common preference for an increasing number of people to do this is mutual funds. A mutual fund involves investing your money, along with other investors into a common pool. It’s a professionally managed investment, run by experienced, competent professionals, who are usually dealing with a corpus (Assets Under Management) running into hundreds if not thousands of crores. Mutual fund schemes come in different varieties – a regular mutual fund, a direct mutual fund (which we will discuss in more detail further in this article) and more.

In terms of popularity, what mutual funds are to the equity markets, a Systematic Investment Plan (or SIP) may be to mutual funds. A vehicle to channel your money into mutual funds regularly, SIPs are the preferred way to invest for many investors looking to achieve their financial goals. Let’s understand why they prefer SIPs.

An Overview of Systematic Investment Plan

The one obvious advantage that a SIP offers is that it helps you in making periodic investments, rather than investing via lump sum amounts. With this, it allows you to customize your own investment schedule as per your preference and goals. These investments could be made weekly, monthly, quarterly, bi-annually or even annually. A fixed amount is deducted from your bank account and used to buy units of a mutual fund. It is one of the most disciplined types of investments made under mutual funds.

Systematic Investment Plans also offer another important advantage – flexibility. You can change your investment amount, or even stop the investment plan whenever the need arises. A SIP is commonly recommended to retail investors or those who don’t have the time to actively participate in the market movements. But a SIP is also ideal for the ones who do not have access to a lot of research and understanding about financial markets. With a SIP, you could say you’re outsourcing your investment management to qualified professionals. One thing that a SIP does exceedingly well is that it develops a habit of saving and investing and brings you closer to your financial goals.

How does a Systematic Investment Plan work?

In an open-ended mutual fund scheme, you can start a systematic investment plan any time you want to. Once the SIP mandate is submitted to the point of acceptance, it can take a few days to register the SIP mandate and initiate it. The date of the amount deduction will also be decided and mentioned by you in the form. These forms are typically submitted along with a cheque.

A fixed amount is deducted from the bank account of the investor to buy units of the mutual fund. These investments can be made through any of these:

  • Post-dated cheques or
  • ECS mandate/auto-debit facility.

The Systematic Investment Plan work on two major principles, namely:

  1. The Power of Compounding

“Compound interest is the eighth wonder of the world. He, who understands it, earns it … he who does not … pays it” – Albert Einstein.

The concept of compound interest can be surprising to many – in the sense that over time, the pace of returns can be substantially faster than what you would expect at first glance. Investors put up a small number of funds to invest and see the value of the fund increase with time. Since the returns you’re earning are a function of your investment amount, they can grow rapidly over time. This is because your investment amount itself is increasing in value. Longer durations naturally attract higher returns. These returns add to your corpus, which means that you will generate returns on your previous returns as well. This is beneficial when the investor has been saving for long.

  1. Rupee Cost Averaging

Another important tenet of investments is cost averaging. SIPs help you avoid the stress associated with ‘timing’ the market and waiting for dips to enter or spikes to exist. You can skip having to think about when and how much to invest. Select the suitable amount of investment and the intervals to make the investment. Since you’re investing at regular intervals, your net cost of units of mutual funds (Net Asset Value) is averaged out – it’s neither too high, nor too low.

SIP is a basically a 7- step procedure, such as:

  • Get the KYC done. This is the one-time step after which an investor may invest in any mutual fund, offline/online.
  • Select suitable mutual fund amidst more than 5000 types of mutual funds.
  • Make the first installment payment online itself and the further investment mediums could be selected. The investor may also opt out for the automated payments for the future investments.
  • You SIP will start. The investor can track the investments on the dashboard and can also see the present value of the unit in the market whenever he/she wants to.

What are the major benefits of Systematic Investment Plan?

Systematic Investment Plans offer a wide range of benefits – from flexibility to higher returns.

  • The primary advantage is that you get to customize your investment plan by opting out for the amount that you want to invest.
  • SIPs allow you to make investments at regular intervals instead of one-time investments.
  • There’s flexibility in choosing the duration of your investment tenure.
  • Very importantly – you’re made to get accustomed to saving more and investing, which eventually leads you closer to your financial targets.
  • As you invest in intervals, market conditions cease to matter too much, as you will receive more units when the market is low (or fewer units when the market is high), which eventually averages the entire purchase cost of the mutual fund units.
  • The power of compounding: by earning further returns on your own returns, you’re compounding your money. This makes achieving long-term financial targets significantly easier.

SIPs for Direct Mutual Funds

Mutual funds are professionally managed investment vehicles. Such professional supervision comes at a cost of course, especially when you’re investing in them via distributors, which further adds to the expenses. Mutual fund houses can charge as much as 1% (or more) for their Regular schemes, which is paid to their distributors. Naturally this 1% is funded by the investors of the mutual funds. Fortunately, it can be easy to avoid these costs – by investing into a separate variant of these schemes – called a direct mutual fund. A direct mutual fund does deduct such charges. As a result, this benefit is directly passed on to the investors of such a direct mutual fund.

When investing in a direct mutual fund, investors typically receive a fewer number of units, since the NAV (Net Asset Value) of a direct mutual fund is higher. A higher NAV means you can buy fewer units of the mutual funds with your money. A common misconception amongst investors is that fewer units will translate to lower returns. But nothing could be further from the truth. The NAV of a direct mutual fund is higher since it has been generating more returns for its investors. Since no extra costs are involved, these returns lead to a higher NAV over time. This is, in fact, a good sign – it indicates that the direct mutual fund performs better than its regular counterpart.

A systematic investment plan combined with a direct mutual fund can turn into a lethal combination. Not only are you saving on costs that you’d be paying if you’d picked regular mutual fund schemes, you’re also on the track to long-term wealth creation with the SIP. The power of compounding, coupled with savings of as much as 1% or more can yield significantly higher returns, in the long run, making a direct mutual an obvious choice an obvious for most investors.

A Systematic Investment Plan is a less stressful strategy for making better investments. It protects investors from the volatility of the market and compounds your wealth from time to time. And it isn’t just the preferred investment option for regular retail investors, but for experienced folks as well. When are you starting your SIP? While you’re at it, remember to pick a direct mutual fund.

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