Imagine being tasked with scaling Everest – the tallest mountain in the world. Do you think you will just be able to wake up one fine morning and climb to the top? No. Similarly, if you want to enjoy the fruits of your hard work later in life, you will need to start preparing and planning for it early, in a systematic and consistent manner.
Systematic Investment Plan, or SIP, offers one an opportunity to generate wealth, with a disciplined and systematic approach, to meet their financial goals. Much like preparing to scale for Everest.
It is a tool that offers you the option of investing in various mutual fund schemes at regular intervals and in lower amounts as well.
One can also chose to invest a fixed amount in mutual fund schemes on a monthly or quarterly basis.
You can reap good returns even by investing amounts as low as INR 500 per month.
Through SIP, one can invest in equity (stock market) or debt markets. It also gives one the convenience to invest in markets without getting worried about market volatility.
Returns offered by SIPs are more attractive than traditional tools such as fixed deposits. In terms of mechanism, SIP works like a recurring deposit scheme where one deposits a fixed amount every month. However, compared to recurring deposits where there is a fixed rate of return and a limited appreciation of investments, SIP offers a variable rate of return, with a higher potential to enhance capital.
You are convinced of going the SIP route for wealth creation. You are also aware of the beauty of averaging and the magic of compounding. But wait, what kind of an SIP would you start? That depends on your financial goals.
The most preferred SIP used by investors is a Fixed SIP, where one can choose to put in a set amount at a regular interval. Mutual fund companies give investors the option to invest on a weekly/fortnightly/monthly/quarterly basis.
This type of SIP allows one to increase the SIP amount at a regular interval. It gives individuals the flexibility to step up the contribution when the mutual fund scheme they have invested in is performing better, and when their income increases.
This kind of SIP allows individuals to tweak the amount they want to contribute. In case of a cash crunch, they have the option of informing the fund house to stop SIP payments till financial conditions improve. Alternatively, one can choose to increase contributions when they have a surplus. The information to alter the SIP investment amount needs to be given in advance.
This type of SIP should be considered only if one can read the pulse of the market. It gives you the option to set the SIP start date or redeem funds as per a selected market event, NAV or index level. However, one needs to be cautious while selecting this kind of SIP and go for it only if their understanding of the market is extensive.
Usually, when one starts an SIP investment, they need to specify its tenure - one/three/five years. A Perpetual SIP does not have a specified tenure. Once financial goals have been achieved, one can stop the SIP.
So what kind of an SIP are you planning to start?
By now, you may have a fair idea of what an SIP does. And you are seriously considering starting one. But you may have doubts about how it really works? Let us put your doubts to rest! There are two distinct advantages to an SIP.
Assume that you want to upgrade your wardrobe. You decide on the number of garments you want to buy and the potential brands from whom you want to. One of the brands has a sale. Wouldn’t you prefer to buy from that store knowing that you will get more in the same budget that you may set aside? Now, if there wasn’t a sale. You would still go and buy from the shortlisted brands as planned but you will not be able to/want to buy more.
An SIP works in a similar fashion. Supposing you invest INR 500 every month. In a given month, if the Net Asset Value (NAV) of your fund is INR 50 per unit, you will be able to accumulate only 5 units. In another month, if the NAV goes down to INR 10 per unit, you will be able to gather 50 units for the same price. If you were to calculate the average price per unit, it would be close to INR 19 per unit. This concept is called rupee cost averaging.
It is important to remember here that rupee cost averaging is not a guaranteed way to make more money or eliminate risks. By staying invested irrespective of market conditions, one is able to consistently grow capital over the long-term.
All of us remember magic shows. We would watch in awe as the magician pulled something out of thin air! Pulled out two objects from the hat when he had only put in one! What if we were to tell you that SIP works in a similar fashion? Only in this case, the magic lies in starting early and staying
consistent. Then watch in awe as your money grows through the magic of compounding!
Don’t believe in magic? Here is an example. Assume you are investing INR 1500 each month through an SIP. At the end of year one, if the rate of interest remains more or less consistent at 10 % pa, you will have made INR 19,800. If you stay invested, in the second year, you will have made close to INR 42,000*. In the fifth year, you will have made close to INR 1,18,000 with an investment of just INR 90,000! Now just imagine how much wealth you will be able to accumulate if you continue putting money in an SIP till you retire! Is it anything lesser than magic?
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