What Is SIP Investment - Meaning and How It Works

SIP (Systematic Investment Plan) is one of the most popular ways of investing in mutual funds, with inflows reaching an all-time high of ₹21,262 crore as of June 2024. If you want to build wealth through investments but lack the time to study the market regularly, SIP is an excellent option you can consider. It allows the investor to set aside a fixed monthly amount and invest in mutual funds, making it easy and systematic.

This article explores what exactly SIP investment is and how it works.

What is a Systematic Investment Plan (SIP)?

A Systematic Investment Plan (SIP) allows investors to make regular payments towards their chosen mutual funds. It is an easy way to invest a fixed amount on a weekly, monthly or quarterly basis. A SIP (Systematic Investment Plan) is a long-term investment plan that requires a recurring fixed investment amount instead of a lump-sum amount. 

SIP offers a disciplined approach to investing and a systematic path to building wealth over time. Investors can choose the frequency of investment, whether weekly, monthly, or quarterly investment and enjoy the flexibility to automate these payments. Additionally, SIP allows investors to increase or decrease their SIP contributions as per their needs.

How Does SIP Work?

SIP allows investors to systematically build wealth while benefiting from two key principles:  Power of Compounding and Rupee Cost Averaging

Power of Compounding: When you re-invest the returns from your SIP, over a long period, it leads to an exponential growth in your returns. This showcases the power of compounding in SIP. For instance: Consider two friends, Neha and Amit:

– Neha begins investing ₹2,000 monthly in a SIP at age 30, with an expected annual return rate of 12%. She continues her investment for 25 years, contributing a total of ₹6,00,000.  

– Amit delays his investment and starts at the age of 40, investing ₹2,000 monthly in an SIP expecting the same 12% annual return. He invests for 15 years, contributing a total of ₹3,60,000.

Here’s how their investments compare by the time they turn 55:

– By age 55, Neha’s investment has grown to approximately ₹26,80,000, thanks to the power of compounding over a longer duration. 

– On the other hand, Amit’s investment has grown to approximately ₹10,35,000 by the time he turns 55, since he invested for a shorter period.

Despite investing the same amount each month, the longer duration of Neha’s investment yields much higher returns due to compounding.

Note: The figures provided are for illustrative purposes only, actual returns may vary.

Rupee Cost Averaging: SIPs help you safely navigate market fluctuations. Regular investments in SIPs even out the average purchase cost over the long run. It simply means that more units are purchased when prices are low and fewer when prices are high. 

For example, if you invest ₹5,000 monthly in a fund:

• In the first month, with a NAV of ₹40, you buy 125 units.
• In the second month, if the NAV rises to ₹50, your ₹5,000 buys 100 units.
• In the third month, if the NAV drops to ₹30, you buy 166.66 units.

For instance, if you invest ₹5000 monthly in a fund, with an NAV of ₹40, then they will buy 125 units. If the NAV increases to ₹50, then the same amount will fetch 100 units. Additionally, if the NAV decreases to ₹30, then the third month will fetch 166.66 units with the same amount. 

Thus, over 3 months, the investor accumulates 391.67 units with an average cost per unit of ₹38.33. The systematic approach helps to smooth out investment costs and could potentially improve returns over the long term, demonstrating the benefit of SIP with rupee cost-averaging.

Also Read: Things to Know About Loans Against Mutual Funds

Types of SIPs Available in the Market

There are many types of SIPs available in the market. Let’s understand what each one of them means and their benefits:

Regular SIP: This is a simple type of SIP, where the investor invests a fixed amount at a regular interval. This SIP investment frequency could be weekly, monthly, quarterly, etc. However, regular SIP is not recommended, since the amount invested cannot be changed during the investment tenure.

Top-up SIP: This type of SIP allows investors to increase their investment amount when they earn higher incomes or have more funds available to invest. This offers the benefit of investing in high-performing mutual funds at regular intervals. 

Flexible SIP: Flex SIP or Flexi SIP, as it is commonly known, offers the investor flexibility to change the SIP amount and frequency based on their financial situation. The investor can pause, increase or decrease their SIP contributions at their convenience.

Perpetual SIP: Perpetual SIP gives the investor the option to choose the SIP for an indefinite term. However, since Oct 2023, NACH (National Automated Clearing House), has introduced a maximum investment tenure of 30 years from the date of issuance. Additionally, it is mandatory to specify the final collection date of the mandate.

Trigger SIP: With a trigger SIP, the investor can set a trigger to certain market conditions or fund performance. It is usually recommended to experienced investors, who have a deeper understanding of the market to set the trigger.

Multi SIP: This SIP allows an investor to invest in multiple mutual funds in a single SIP. The benefit of multi-SIP is that it allows diversifying the portfolio by spreading the risk, thereby optimising the returns.

Benefits of Investing Through SIP

SIP (Systematic Investment Plan) is a popular investment plan that allows one to invest in a disciplined and consistent manner. The benefits of SIP are as follows:

Rupee Cost Averaging: SIP investors benefit by rupee cost averaging. The investor can adjust mutual fund units as per the market fluctuation. 

Power of Compounding: SIPs harness the power of compounding, where the returns earned are re-invested in the mutual funds that grow exponentially over the long term.

Flexibility: SIP provides flexibility in investment. Investors can change the SIP amount as per their investment capacity or market conditions.

Low Risk: Investing a large amount towards a single investment could prove to be risky in the future. SIP is spread across a long period and helps the investor to minimise the risk.

Financial Discipline: It encourages one to save regularly since a fixed amount goes towards the SIP. If one finds it difficult to save money, they can start with a SIP to save monthly and build their wealth over time.

Also Read: Advantages and Disadvantages of Digital Loans Against Mutual Funds

How to Start a SIP Investment

To begin with a SIP investment, consider the below-mentioned points:

1. Set Financial Goals: To set a goal for SIP investment, determine your financial goal, risk appetite and investment tenure. 

2. Choose a Mutual Fund scheme: Once that is decided, choose a mutual fund scheme that best fits your financial goals. There are varied mutual fund schemes to choose from.

3. Keep Documents Ready: Before you apply, ensure all the documents are ready including

• Identification Proof
• PAN Card
• Address Proof
• Check and verify your bank details are correct. You may also need to provide a copy of your passport or driving license.

4. Register & Apply: To start a SIP, register with a financial advisor or an Indian broker. Once the registration is completed, you can choose an investment plan from the pool of options available

5. Choose the Right Plan: It is important to assess your ROI expectations and risk appetite when you choose a SIP. 

6. Fix the Amount to Invest: Decide how much money you are willing to invest on a monthly or weekly basis in your SIP. 

7. Select the SIP date: Fix the date where the SIP amount will go towards the investment. 

8. Submit Form: You can submit the SIP form online if you have an online demat account. Most banks offer auto-debit to Mutual funds. You can also submit the form offline, through bank or post offices.

Factors to Consider Before Starting a SIP

Before starting a SIP, you need to factor in these factors, to get the most out of your investment. This will help you manage your investments better and more efficiently:

Determine Financial Goals: Assess your long-term, mid-term, or short-term financial goals. Additionally, you can set up multiple SIPs as per your financial goals.

Assess Risk: As an investor, it is important to factor in the level of risk you are willing to take with your investments. Mutual fund risk can be categorised into low, medium or high risk based on the type of securities. It also depends on one’s income, age, financial expenses etc. A diversified portfolio is a smart choice if one has a low-risk appetite.

Check Credentials of Fund Manager/Company: Ensure the asset management company you select is well established and has a good record of managing mutual funds. Check the fund manager’s expertise, focusing on those with long-term experience in managing portfolios.

Common Mistakes to Avoid When Investing in SIPs

When investing in SIP, it is important to understand why you are investing and what risk you can take.  If you’re a new investor, avoid these common mistakes:

Not having a financial goal: When starting a SIP, it is important to decide the purpose of investment. Whether it is a retirement fund, home buying or financial security, having a clear objective will help you choose a plan that aligns with your needs.

Choosing a high amount: The SIP amount is contributed to the investment regularly (weekly, monthly, or quarterly)  Setting a high SIP amount can strain your budget and disrupt your other monthly expenses. Consider your future expenses for over a year before you set your SIP amount.

Investing for short duration: Certain mutual funds like equity mutual funds give good returns if you invest in them for the long term. Additionally, investing for the long term will even out the market risk through rupee cost averaging.

Not considering market risk: There is a certain level of risk attached to every investment. Debt funds have less risk since they are fixed-income securities such as bonds, investment securities, and money market instruments. Whereas, equity funds are riskier since they include stock market investments that fluctuate frequently.

Conclusion

SIP enables individuals to build wealth through consistent investments over the long term. It is a smart approach to investing in mutual funds if one lacks have time to regularly check market conditions. You need to define your financial goals and choose the investment amount that fits your long-term financial goal. You can consistently build wealth for your financial goals like home buying, retirement or education funds for your kids.