What is SIP? SIP, or Systematic Investment Plan, is a widely used term in the world of investing. You may have come across this term in various media outlets, including television, radio, blogs, articles and more. But what exactly does SIP mean? Or, more precisely, what is SIP in mutual funds?
Let’s learn about SIP and mutual funds in detail.
The Association of Mutual Funds in India (AMFI) defines a mutual fund as a collective investment vehicle that collects and pools money from a number of investors. This pooled money is then invested in a diversified portfolio containing equities, bonds, government securities, and money market instruments.
How Does Mutual Fund Work?
A mutual fund is managed by the Asset Management Company, or AMC, an entity responsible for managing and investing the pooled funds on behalf of the investors.
When you invest in a mutual fund, your money is combined with funds from other investors. In return, the mutual fund allocates a proportionate number of “units” to you, based on the prevailing Net Asset Value (NAV). As a mutual fund investor, you can earn returns through income distributions from dividends, interest, or capital gains. Additionally, when you sell your mutual fund units, you may yield a profit or loss depending on whether their value has increased or decreased since your initial investment.
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Methods of Investing in Mutual Funds
There are two popular methods of investing in Mutual funds:
1. Systematic Investment Plan (SIP)
A SIP allows investors to invest a fixed amount at regular intervals. One key benefit of this approach, particularly in equity schemes, is that it averages the cost of acquiring units. For instance, when the market prices are low, more units are purchased for the same investment amount, and when prices are high, fewer units are acquired.
Let’s understand this with an example. If an investor invests ₹1,000 per month for 12 months, and the NAV in the first month is ₹10, they will be allotted 100 units (₹1,000 ÷ ₹10). In the second month, if the NAV rises to ₹12, the investor will receive 83.33 units (₹1,000 ÷ ₹12). Conversely, if the NAV drops to ₹9 in the third month, the investor will be allotted 111.11 units (₹1,000 ÷ ₹9).
This illustrates how an investor benefits from acquiring more units when the NAV decreases and fewer units when it increases, thereby averaging the cost over time. This process is called rupee cost averaging.
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2. Lumpsum Method
The Lumpsum method involves investing a large, one-time amount into a mutual fund rather than making smaller, ongoing investments over time. For example, if you invest ₹1,00,000 into a mutual fund with a Net Asset Value (NAV) of ₹10, you will receive 10,000 units. If the market performs well after your lumpsum investment, this strategy may yield higher returns. However, the fluctuating NAV can affect the entire investment and pose a higher risk due to immediate exposure to market volatility. Unlike a Systematic Investment Plan (SIP), the lumpsum approach might not benefit from cost averaging, making it more dependent on the timing of the investment.
Steps to Start Investing through SIP
Step 1: Complete Your KYC
To start investing through a SIP, you must first complete the KYC (Know Your Customer) documentation process. Thanks to technology, this can now be done online using platforms like Kuvera. You’ll need to submit:
- Address proof
- Identity proof
- A photograph
Step 2: Identify Your Investment Goals
Once your KYC is set up, the next step is to define your investment objectives. Outline your financial goals and look for funds that align with these goals.
Step 3: Choose Your Plan
Next, select the investment parameters for your SIP. Choose a plan that matches your risk appetite and financial goals. You’ll need to provide additional details, such as the tenure, investment frequency, and investment amount, as required.
Benefits of Investing through SIP
The SIP approach offers you several advantages, including:
1. Regular and Automated Investments
SIPs allow you to invest a fixed amount at regular intervals, such as monthly or quarterly. This automation removes the need for manual transactions and helps build a disciplined investment habit.
2. Affordability
SIPs enable you to start investing with relatively small amounts (as small as ₹100 and ₹500). This approach is particularly beneficial for those who want to start investing but have limited capital.
3. Cost Averaging
As explained in methods of investing in mutual funds, by investing regularly, you benefit from rupee cost averaging.
4. Flexibility
SIPs offer flexibility in terms of investment amount and frequency. You can adjust the investment amount or frequency as your financial situation changes, making it easier to adapt to changing needs. For instance, you get the option to pause or stop SIP. You might choose to pause SIP if you need to stop investing due to financial reasons or personal circumstances temporarily. However, you can restart the SIP from where you left and can also modify your SIP investment.
5. Convenience
Most mutual fund providers offer online platforms for managing SIPs, allowing you to set up, monitor, and modify your investments with ease from anywhere.
6. Compounding Benefits
Regular investments over time can benefit from the power of compounding, as the returns earned on your investments can be reinvested to generate additional returns. It is an effective tool to beat the heat of inflation in the long run.
7. Low Risk
SIPs spread your investments over time, which can help mitigate the risk of investing a large sum all at once during market highs or lows.
Challenges Associated with SIP Investments
SIPs have several disadvantages too. They include market risk, potential missing gains, over dependence on the fund manager, limited control over timing and pricing, exit load and lock-in periods, and expense ratios.
1. Market risks can cause temporary losses if the market experiences a downturn, while the potential for missing gains is higher for beginners who invest regularly at specified intervals.
2. Over-dependence on the fund manager can impact overall returns if their performance declines or changes in the fund’s management team occur.
3. Limited control over the timing and pricing of SIP investments may not align with personal financial circumstances or market expectations.
4. Exit load and lock-in periods can make mutual funds unattractive for sudden withdrawals, reducing returns.
5. The expense ratio is the annual fee paid to the AMC when investing in a mutual fund scheme, which can be as high as 2.25% for equity schemes and 2% for debt schemes.
Nevertheless, wealth creation starts with a well-planned investment portfolio, which can be achieved through mutual fund SIPs. SIPs offer diversification across emerging sectors, investing in different companies and assets proportionately. For instance, hybrid funds allow investors to invest in equity shares, debt securities, or gold in a pre-decided proportion. They also invest in various sectors like information technology, healthcare, banking, and financial services, thereby diversifying risk and optimising returns.
Overall, the SIP approach simplifies the investment process, making it more accessible and manageable for investors at various stages of their financial journey.
As this stream has advantages and challenges, therefore it is said that ‘Mutual Funds are subject to market risks, read all scheme related documents carefully’. Popular of these documents are Scheme Information Document (SID), Statement of Additional Information (SAI) and Key Information Memorandum (KIM), and Factsheet among others.
Now that you have understood what is SIP, you can confidently choose a scheme and start investing. Check this link.
Wrapping Up
SIP investing is the simpler, convenient and cost-friendly approach to mutual fund investing. Once you are aware of what is SIP, you can go ahead and choose a scheme of your choice and invest with ease and confidence.
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DISCLAIMER: Mutual Fund investments are subject to market risks. Read all scheme related documents carefully. Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors. Investments in securities market are subject to market risks. Read all the related documents carefully before investing. The securities quoted are for illustration only and are not recommendatory.
