What is SIP?

Aug 11, 2022

What is SIP?

A systematic Investment Plan, commonly referred to as an SIP, allows you to invest a small sum regularly in your preferred mutual fund scheme. By activating an SIP, a fixed amount is deducted from your bank account every month, which gets invested in the mutual fund of your choice.

Unlike a lump sum investment, you spread your investment over time with an SIP. Therefore, you don’t need to have a large amount of money to get started with your mutual fund investment through SIPs. By investing via an SIP, you are forced to set aside a sum at regular intervals, which help you instil a sense of financial discipline in the long run.

How it works 

Every time you invest in a mutual fund scheme through an SIP, you purchase a number of fund units corresponding to the amount you invested. You don’t need to time the markets when investing through an SIP as you benefit from both bullish and bearish market trends.

When the markets are down, you purchase more fund units while you purchase fewer units when the markets are surging. Since NAV of all mutual funds are updated on a daily basis, the cost of purchase may vary from one SIP installment to another. Over time, the cost of purchase averages out and turns out to be on the lower side. This is known as rupee cost averaging. This benefit is not available when you invest a lump sum.

Rupee Cost Averaging

SIP helps you invest in equity funds without having to time the stock market. You invest a fixed amount regularly across stock market levels when you invest in equity funds through the SIP.

It helps you buy more equity fund units when the stock markets are crashing and lesser units when markets rise. You will be averaging out the purchase price of equity fund units over time thereby lessening the impact of short term market fluctuations on your investment.

Lets understand Rupee Cost Averaging with an Example: Suppose you invest Rs 1000 every month in an equity fund through an SIP. Stock markets are highly volatile and the Net Asset Value (NAV) of the equity fund keeps changing. It means you will not be able to invest at the same NAV every month. If you invest Rs 10,000 every month from January to June in a particular year your SIP investment could look like this.

Compounding 

Power of Compounding helps you magnify your returns over time. It is basically a return on your returns from equity mutual funds. For example, suppose you invest Rs 100 in an equity fund which fetches you returns of 10% per annum. You do not take out your profit from equity funds which is effectively reinvested in the mutual fund and your total corpus is Rs 110. The returns you now earn from the equity fund are on Rs 110 and not Rs 100 which is return on your returns.

You can invest in equity funds through the SIP to enjoy the power of compounding. It helps if you start your SIP as early as possible and stay with your investment for the long run to enjoy the power of compounding benefit.

Lets understand the power of compounding with an example. Suppose four people, Ramesh, Suresh, Mahesh and Uday who are 30, 35, 40 and 45 years old have invested Rs 5,000 per month in equity funds through the SIP. Let’s assume equity funds offer an annual return of 12%.

The table below shows their accumulated corpus at retirement at the age of 60 years.

Advantages of investing in SIP 

You may have guessed a few advantages of SIPs for yourself from the definition. But here’s a complete list of advantages SIPs can offer you:

You can start small: 

When you start earning, income is low, expenses are high, and the most common excuse to postpone saving is, ‘my income is too low’. Well, not when you can SIP your way to any mutual fund and many investment schemes.
SIPs give you that edge if you want to start with just Rs. 1000 you can. For long-term wealth, this is what matters – develop a habit of saving.

Start Investing Early: 

Do you know? “You have a better chance of getting Rs. 1.5 lakhs 10 years later by investing Rs. 850 a month, than starting in the 10th year and investing Rs. 10,000 a month.”
If you want to achieve bigger financial goals. Don’t wait to start saving great amounts. Start with whatever you have. SIPs help you take advantage of an early start.
Your earliest savings get the higher benefit of compounding, and as shown in the example above can grow quite a lot over a longer time.

Convenient to Continue: 

With SIPs you can choose your frequency. You can invest monthly or even weekly if your income permits. The best part is that you can customize SIPs to match your income frequency. So, you don’t have to think about your savings all the time.

Automate your investments: 

One of the biggest advantages of SIP is that you can automate your savings to investment transactions. As the thumb rule of saving goes, ‘save before you spend’. You can use the auto-debit mandate to automatically transfer money from your salary account to various investments every month.
So regardless of whether you feel like investing or not, the money will keep flowing to your investments and towards your financial goals.

Benefit from Rupee Cost Averaging:

 Rupee cost averaging is an interesting development from the SIP mode of investing. As you invest your average cost of investment goes down and your returns stabilize. The longer you keep investing, the better it becomes.
See ‘How Does SIP Work?’ below, to understand the effect of SIP on your portfolio.

Conclusion

SIP is a great way to go about your investments but it is to be noted that it’s still subject to market risk. 

On top of that, online marketplaces like LenDenClub further simplify the process for investors. Let us see how –

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*P2P investment is subject to risks. And investment decisions taken by a lender on the basis of this information are at the discretion of the lender, and LenDenClub does not guarantee that the loan amount will be recovered from the borrower.

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