SIP in mutual fund and its benefits

Raj, an IT software professional just stepped into Bangalore for his first job. He has plans to go in for higher studies after 3 to 5 years and bear the expenses from his salary. He decided to invest his savings. He has always seen his father investing in fixed deposits, but considering high inflation he chose to meet a financial advisor. When he asked the advisor about SIP, he replied “Little drops of water make the mighty ocean”.

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The advisor advised him to invest in Mutual Funds using Systematic Investment Plan (SIP) since he cannot afford a lump sum amount to invest. He got to know that he just has to invest the fixed amount which he can spare out of his salary every month.

A good number of investors in India are looking forward to invest via mutual fund SIPs to enter the equity markets and to take advantage of the compounding returns. Raj understood what the actual concept behind systematic investment plans is. He just has to invest a small amount at regular monthly interval by choosing a good mutual fund scheme.

Investors of systematic investment plans (SIP) can choose from various category of funds to invest their money into mutual funds like diversified equity funds, balanced funds, mid and small cap funds and even gold funds.

What is SIP

SIP is nothing but small amount of money invested on a pre-selected date of every month into a specific mutual fund scheme of the investor’s choice. SIP is the model way to initiate investment into equities and building long term savings. Laymen have a superficial understanding of the lows and highs of the market. With SIP one does not need to actively time the market before investing. There is no worry over entering the market at the wrong time, wondering if you missed a huge windfall or if the market is on the edge of a downfall.

SIP is a tool that is used by mutual fund companies (AMCs) all over the world including India as a convenient means by which investments can be made by the investors into equities.

When Raj asked for the advantages of mutual fund SIP, below are the points the advisor had to say -

Small amount and big gains

SIPs allow investors to invest small amounts every month. In fact in ELSS mutual fund schemes you can invest an amount as small as Rs 500 a month. This is how small saving can lead to higher returns in the long-term.

Rupee Cost Averaging

Rupee cost averaging is another significant reason why many investors are considering SIP nowadays. Considering a long term investment approach, rupee cost averaging can even out any market ups and downs in the long term, allowing the investor to gain maximum benefits on his or her investments over time. Investing a fixed amount of money every month towards any investment vehicle allows them to purchase more units or stocks when the price of the investment is lower. This reduces the average cost of purchasing of the financial asset over time.

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.

Illustration of Rupee cost averaging:

Power of compounding

An investor who starts early is the one who is successful. SIP allows one to invest with a minimal amount so anyone starting off early will be highly benefited than the one starting off with a big amount years later than him, since all investment and returns are based on the power of compounding which helps one earn return over returns.

Let us examine as cenario -

Mr. A started investing in a mutual fund systematic investment plan (SIP) investing a sum of Rs. 5,000 when he was 30 years old. By the time Mr. A reaches 50 years of age, he would have accumulated Rs 50 Lakhs against his investment of Rs 12 Lakhs assuming that the SIP investment grew on an average rate of 12% per annum.

Now let us consider Mr. B who starts out earlier than Mr. A and started investing the same amount of Rs. 5000 from the time he was 20 years of age or ten years earlier than Mr. A. Mr. B's investment growing at the same rate of 12% per annum would fetch him Rs 1.76 Crores against his total investment of Rs 18 Lakhs.

So while both Mr. A and Mr. B invested same amount each month, the one starting out early has made a substantial gain compared to the one starting out late.

Investment convenience

SIP allows the advantage of investing in small amount of money each time without any hassle to the investor. The investor can send an one-time instruction know as SIP ECS mandate form to his bank to allow auto debit of the fixed investment amount each month from his bank account without worrying about missing out on any monthly instalments.

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Load waived off

Some fund houses (AMCs) have waived off entry or exit load on mutual fund SIP in case. However, the investor must check the same with respective AMC when starting the SIP.

Tax benefit

Investment in Mutual Funds either through SIPs or lump sum offers many a tax benefit. For example - dividend received from equity mutual funds are totally tax free. Long term capital gains in case of equity funds (investment holding period of more than a year) are also tax free. In case of debt funds the long term capital gains (investment holding period of more than 3 years) is taxed @20% only after allowing indexation benefit.

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Discipline

Disciplined approach towards investment helps the investor to keep his emotions in control. Investing in equity mutual funds can be tricky because the stock markets are volatile. Investors tend to shy away from equity because of the ups and downs they witness. But in doing so, they give up on the opportunity to generate high returns over the long-term. Equity has proven to be the best-performing asset class over long period of time, which is when the magic of compounding returns starts to show. But to get the best of this, you need to not only invest regularly but also stay invested.

Please also read why you should stay invested with mutual fund SIPs

Investors should however, note that SIPs can be started only in open-ended mutual funds schemes where the investors can invest and redeem anytime.

There is no fixed tenure for running a SIP. Full and partial withdrawal is possible during or after the SIP tenure. The investor can close the SIP whenever he or she wishes, by writing to the AMC.

How does SIP work

An SIP is a periodic mandate that is given to the mutual fund to deduct a fixed amount from your bank account at a designated date which is chosen by you.

For example, if you decide to invest Rs 10,000 in a mutual fund scheme through a monthly SIP, the fund company will use the ECS facility to deduct that amount from your bank account at a pre-decided date every month.

SIPs are beneficial because investing in lump sum has many pitfalls. When you invest lump sum in an equity mutual fund, you run the risk of catching a market peak. What this means is that you might invest on a day when the market is at a high. The stocks markets are volatile and if they go down after you’ve made a lump sum investment, you will see major erosion in your invested amount. This will lead to a monetary loss and might turn you away from equity investing and away from creating wealth over the long-term.

Conclusion

Raj is now satisfied that he will be able to do justice to his hard earned money and is looking forward to cherish his goals innear future.