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What is Systematic Investment Plan (SIP)?

dateKnowledge Centre Team dateDecember 20, 2022 views289 Views
What is SIP | How to Invest in SIP | Financial Planning

A systematic Investment Plan (SIP) is an investment strategy offered by mutual funds. SIP is an investment facility where the investor can make a systematic periodic investment in market-linked funds for a specific tenure. The investor can make the investment in small amounts instead of lump-sum. It can be made in the frequency of weekly, monthly, or quarterly. By taking the SIP route to assets, the investor puts in a time-bound manner without worrying about the market dynamics and stands to benefit in the long-term due to average costing and power of compounding.

A systematic investment plan is a financial investment you can choose to make the best of a mutual fund. As the name suggests, SIP is a planned investment toward your desired mutual fund for prolonged benefits.

Let us understand in detail about what is SIP and how it works.

What is SIP - Systematic Investment Plan?

A Systematic Investment Plan (SIP), more commonly known as SIP, is an investment route provided by mutual funds to the investors to invest in a disciplined manner. SIP allows an investor to invest a fixed amount of money in his preferred mutual fund scheme at pre-defined intervals. The fixed amount of instalment money can be as low as Rs. 500. The SIP intervals at which the fixed amount is invested can be weekly, monthly, quarterly, half-yearly, or yearly based on their chosen plan.

Under the SIP plan, one can invest an amount as low as ₹500. The intervals at which the amount is deducted can be weekly, monthly, quarterly, half-yearly, or yearly based on their chosen plan. As SIP plans are pretty flexible in terms of amount and intervals, you don’t need to have a large sum of money to start with.

Unlike other investments, you don’t have to deposit a lump sum amount. Once the investor validates a SIP, a fixed amount of money is regularly deducted from their linked bank account.

After started investing in SIP, the investor does not have to worry about the market dynamics and gets the benefit of staying invested for long-term due to the power of compounding and average costing.

Learn more about SIP and its advantages.

Types of SIP (Systematic Investment Plan)

Currently, most Indian banks and mutual fund providers offer four main types of SIP plans as described below:

1) Top-Up SIP

As the name suggests, Top-Up SIPs let you increase your SIP investment amount after a certain period. For example, if you are currently investing ₹1000 each month, you can choose an increment of ₹500 after every six months making it ₹1500 after 6 months, ₹2000 in another 6 months, and so on.

2) Flexible SIP

A flexible SIP plan lets you control the investment amount according to your cash flow. In this way, you can increase or decrease the current fixed amount even before seven days of the next installment.

3) Perpetual SIP

A perpetual SIP doesn't have a fixed end date of the plan. Thus, it gives you the full right to stop the SIP investment anytime you want.

4) Trigger SIP

Preferred by experienced investors, this SIP plan lets you set a trigger. This trigger automatically redeems itself, allowing you to swap between schemes whenever the market becomes volatile.

How does Systematic Investment Plan (SIP) Work?

Systematic investment plans or SIPs mean that you are investing a fixed sum at regular intervals, usually, monthly. SIP mode of investment works best with volatile assets like equity stocks, mutual funds or equity funds in ULIPs

Every time your SIP gets to the fund you receive a number of units based on the ongoing NAV. NAV is based on the fund performance and market values of the stocks. Thus, when markets move up so does the NAV, and when the markets are in a slumber NAVs too, take a nap.

When you are investing a fixed amount of money, a high NAV gets you fewer units, and a low NAV will get you more. Thus, gradually, the weighted average cost of your total units is lower than the average NAV you have experienced.

For example, assume you are investing Rs 10,000 per month in an equity fund. The result of your 12 months of investing can be as follows:

Month Nav Units Your Average Cost NAV Average
April 25 400.0 25.0 25.0
May 20 500.0 22.2 22.5
June 22 454.5 22.1 22.3
July 24 416.7 22.6 22.8
August 30 333.3 23.8 24.2
September 35 285.7 25.1 26.0
October 32 312.5 25.9 26.9
November 29 344.8 26.3 27.1
December 27 370.4 26.3 27.1
January 21 476.2 25.7 26.5
February 19 526.3 24.9 25.8
March 17 588.2 24.0 25.1
Total Units   5008.7    

Here, Your Average Cost = Total Investment / Total Units

= 120,000/5008.7 = 24, and

NAV Average = Total NAV / Total Months

= 301 / 12 = 25.1

Notice how your average cost of units is 24 while the NAV average for the period is 25.1. Thus, despite investing the same amount in the high markets, your portfolio still remains profitable.

This phenomenon is called ‘rupee cost averaging.’

Benefits of Investing in SIP

SIP mode of investing has several benefits for investors. Some of the most important benefits you can draw from SIPs are:

1. Maintain Financial Discipline

SIPs are a regular automated mode of investment. This means that once set up, it can continue directly from your account without your intervention. This builds financial discipline necessary for long-term wealth building.

2. Rupee Cost Averaging

Rupee cost averaging helps you lower the risk of investing in volatile assets like equity. It also improves your chances of earning a positive return from the market.

3. Power of Compounding

SIPs help you achieve the power of compounding on higher investment value. Plus, you can stay invested longer, improving the compounding effect on your investment.

4. Higher Returns

SIPs can assist you in generating better returns. While rupee cost averaging keeps your average cost lower, regular investing means you are never out of the market. In short, you cannot miss a market opportunity with a regular SIP.

5. Convenience of Investing

You can set up SIPs adjust your monthly budget and relax. Automated SIPs are the best way of investing because you don’t have to worry about it every now and then.

6. Even Small Investors can Invest

SIPs allow you to invest as low as Rs 500 a month. This means you can start an SIP even at a low income and build wealth.

7. Safer Way of Equity Exposure

SIPs are the safest way of investing in equity markets. Even if you want to invest directly in stocks, and can allocate sufficient funds every month, SIP mode is the best way to safely benefit from the equity market.

Must Read - What is Direct Investment?

Why should you Invest in SIP?

Apart from the ease of investment and the lowest possible investment amount, several other reasons make it an investment habit.

1) Power to Stop

Unlike insurance, savings plans, or other kinds of investment where you have to wait for a certain period before you can stop, you can stop SIP anytime.

2) Easy to Skip Payment

One of the popular benefits of the SIP is that you can skip the payment for a month (if your plan has a monthly investment option). Yes, you can skip the payment, and in the next month, you can continue the SIP by paying the coupled amount. This feature is quite beneficial as it doesn't allow your investments to stop due to any financial crunch.

3) Safety from Market Dynamics

The SIP provides you with a safety net from the market dynamics. If you invest today and the market is going down, it won't affect your returns. As the SIP calls for investment over a while, the downs and ups of the markets get averaged out.

4) Start New

The SIP also offers you the freedom to run two or more plans in parallel. If you begin with a small investment earlier and now have increased income or resources, you can start a new SIP and set new goals.

5) Start with just Rs 500 a Month

The best part about SIPs is that even when your salary is low you can start investing. The minimum SIP amount can be as low as Rs 500 per month.

6) Support Emergency Fund

SIPs are flexible and allow partial and full withdrawals without hiccups. So, in the case of emergencies SIP funds can support your financial needs.

How to Invest in a SIP?

Just as with the SIP itself, the process to invest in a SIP is simple. Here are the steps that you should follow to make a SIP investment:

1. Set a Financial Goal

Setting an investment goal for your SIP means your activity will be more fruitful and avoids being cancelled after a while. It also gives you a milestone to track the performance of your SIP.

This will also tell you the SIP amount.

2. Choose a Fund for your SIP

You can SIP into riskier funds if you have sufficient time, for example, equity funds for 5 years or more. For shorter durations, you can invest in hybrid or even debt funds.

3. Complete the KYC (Know your Customer)

You can do that through various e-KYC (i.e., electronic KYC) facilities by mutual fund providers. Fill in the details and upload copies of documents like Aadhar card, Cheque book, PAN card, photograph, etc. Next up, there would be in-person verification for which you need to schedule an appointment.

4. Set up SIP Duration

Finalize the SIP plan by selecting the SIP plan’s investment amount, instalment dates, and duration. All three are going to be important, especially the duration. This is the maximum time for which your SIPs will continue.

SIP or One-Time: How should I Invest?

SIP or one-time lump sum investment question is quite common for high-risk investors. With strong arguments siding with either side, here’s a comparison of terms and situations which make both investments different:

Context SIP Investment Lump-Sum One-Time Investment
Investment amount Small Large
Investment duration Short to mid, i.e., 12 months to 36 months, before you will need to revise Long, 1 to 10 years or more
Discipline Yes No need, but postponed withdrawals help growth
Recommended assets Equity Funds Debt funds and fixed income investments like FD
Taxability Best for equity fund investments as LTCG benefits available only after 12 months Best for debt funds as LTCG benefits are available after 36 months
Investment Risk Low High
Rupee Cost Averaging Yes No
Who Should Invest? Salaried and self-employed Investors, small investors, safe investors Self-Employed Investors with variable income, aggressive investors, pensioners

How to Choose the Right SIP?

The right SIP would be the one which helps you meet a financial goal in the future. So, here’s how you can select the right SIP each time:

1. Fund House

Fund houses are the asset management companies (AMC) which will be investing your SIPs and managing the funds. Check the historical performance record of the fund house or the AMC to know their strengths.

2. Fund Size

Historically, large funds with assets under management of more than Rs 500 crores, have had more stable growth than smaller funds. So, if you are looking to invest safely funds with AUMs higher than Rs 500 crores should be your choice.

3. Decide a Duration of SIP

When you are clear about your financial goal, the duration of the goal is also clear. Based on your investment capacity you can decide to run your SIP for a number of months. Usually, for long-term investors, 36 months is a good duration, as it gives you a chance to revisit the fund and revise SIP.

How to Customize your SIP?

You may want to customise your SIPs according to the new situation or plan. Fortunately, some level of customisation is possible in SIPs:

1. Changing the SIP Amount

If you want to increase the SIP amount it’s better to start a new SIP with the balance amount. However, you will need to cancel the current SIP and start a new one with the decreased amount.

2. Changing the Tenure of SIP

Extending the tenure of an SIP is much easier as you can start a new SIP for the balance tenure after the current one ends. However, you can also connect with your advisor for submitting a request for tenure change, including decreasing the duration or number of SIPs. Usually, you will need to complete the minimum SIP tenure before asking for a change.

3. Switching SIP Funds

If you want to redirect the SIP amount to another fund, the best way is to cancel the current SIP and start a new one. Redirection from one fund to another is only possible in ULIPs. With mutual funds cancellation is the only option as each fund is managed differently.

Tax Benefits of Investing in SIP

SIP is a mode of investment and not an investment instrument. Thus, SIP does not offer direct tax benefits. However, you can maximise your tax savings with SIPs. Here’s how.

SIP can offer you tax benefits in the following two ways:

1. SIP in Tax Saving Funds

Investment in mutual funds like equity-linked savings schemes (ELSS) is eligible for deduction under section 80C. Other than this SIP in ULIPs will also qualify for a tax deduction.

2. Maximise your Tax Saving Investment

SIP is a monthly investment mode, meaning you can start early in the financial year and continue throughout. You can invest more by allocating Rs 10,000 p.m. than by allocating Rs 100,000 in a year. This way SIPs distribute the savings over a period of time and help you save more.

FAQs Related to SIP

1. What are the mistakes to avoid when investing in SIP?

SIPs are to instil discipline in your investing habits. So, you would like to avoid breaking the stream in any way. Here are the things you should avoid with SIPs:

a) Skipping SIP payments
b) Stopping SIP before time
c) Reducing the SIP amount midway
d) Switching funds too quickly

2. What is SIP (Systematic Investment Plan) in mutual funds?

A systematic investment plan or SIP in mutual funds is a mode of investing in mutual funds. You can invest in a lump sum or through monthly SIPs. You can even have multiple SIPs in a single fund.

SIP is a standing instruction you can give to the fund for a regular investment of a fixed sum for a fixed number of months. All you need to do is select an amount, date of investment and duration for your SIPs and the amount is automatically deducted from your account.

3. Why choose a Systematic Investment Plan?

A systematic investment plan offers many benefits to all classes of investors. You can start with a very small amount. The best part is that SIPs let you build a large corpus with small regular investments. Automatic deduction and allocation keep you free from worrying about your investment. It also makes investing in your goals easier as you can decide once and let it grow until you achieve your goal.

4. When should I invest in SIP?

SIPs take away the need to time the market investments. You can start in any situation, whether in a peak or a bottomed-out market. So, the best time to start your SIP would be as soon as possible.

5. How to stop an SIP?

You can submit the form for stopping SIP with your advisor or mutual fund house. You can submit the form online through the fund house website for direct funds.

6. Should I invest in SIP for long-term financial growth?

SIPs are the best mode of long-term financial growth. You can invest small sums, diversify your investment and safely grow your money, even with equity exposure.

7. What is Top-up SIP?

Top-up SIP or Step-up SIP is the SIP you can start to increase your existing SIP investment. This allows you to increase your investments into the funds as your income grows without starting a new portfolio.

8. What is an SIP Account?

SIP account is the process through which you can start investing a small sum at regular intervals into mutual funds. Active SIP accounts keep your savings working towards your goals, and add to your long-term wealth.

9. Which SIP is the best?

The best SIP is the one which helps you achieve your goals effortlessly. An SIP in a fund of your choice where the risk profile of the fund matches your risk appetite is a good way to start your SIP journey. Equity or hybrid mutual fund SIPs are considered best as they offer growth with the safety of rupee cost averaging. Also, you can allocate your savings to more than one SIP. This will keep your investments diversified and more stable than the markets.

10. What is NAV in SIP?

NAV or net asset value is the market value of one unit of the fund in which you are investing through SIP. NAV can be used to measure funds performance. NAV is the price at which you can buy or sell units in the fund when you invest and withdraw respectively. NAV depends on the value of the securities held by the fund and its performance (earnings) over time.

11. How to select mutual funds for SIP?

You should select mutual funds for SIP as per your investment objective and financial goals. For example, equity funds are best if you are looking to invest for the long-term and have a good risk appetite. For lower risk, you can look for hybrid and debt funds.

12. How to increase the SIP amount?

You can start a top-up or step-up SIP whenever you want to increase the SIP amount in the same fund. You can also start a new SIP if the increment amount is higher than the minimum SIP amount.

13. How much should I invest in SIP?

You can either allocate your savings in SIPs or invest as per your financial goals. You can use an SIP calculator to estimate your ideal SIP amount as per your goal. You can start an SIP with as low as Rs 500 per month.

14. How to calculate tax on SIP?

You can ask for the capital gains certificate from your mutual fund advisor. Capital gains are classified into short-term and long-term based on the duration for which you held the allocated units. For equity funds, if you hold the units for 12 months before selling, the gains will be long-term capital gains (LTCG). In debt funds, the period is 36 months. Selling units within this period will cause short-term capital gain (STCG) or loss. STCG is added to your taxable income and taxed at the slab rate. LTCG will be taxed at 20% after indexation.

15. What is OTM in SIP?

OTM stands for ‘one-time mandate.’ OTM allows you to instruct your bank to credit the SIP sum at a specific date each month to the mutual fund. OTM is necessary for you to have a seamless SIP investment. With OTM you can start SIP and relax about your savings turning into investments.

16. How safe is SIP investment?

SIP investment is a way to lower your investment risk of equity market allocation. However, SIPs do not eliminate the market risk of equities. Also, SIPs to debt funds will offer more stable growth, due to the already low risk of debt funds. Thus, SIPs are safe but investment risk and volatility may arise from the asset choice.

17. Which is better FD or SIP?

FD is good for safe short-term investment. Whereas, whereas SIPs allow you to expose your money to market-linked growth. You can SIP into equity funds and other volatile investments, while FDs offer a fixed rate of return over a short period.

18. SIP or RD which is better?

The only difference between SIP and RD is that RDs offer a fixed rate of return. SIPs on the other hand let you invest in high-risk mutual funds like equity funds and corporate debt funds. Interest credited in RDs is also taxable each year, while capital gain of mutual fund SIPs will be taxable only upon withdrawal.

19. What are the minimum and maximum amounts I can invest in SIP?

For now, you can start SIPs with as low as Rs 500 and there is no maximum limit of investment. However, funds may classify your investment separately if the amount exceeds Rs 1 lakh a month.

20. How to shorten the duration of SIP?

You can submit a cancellation request to the fund manager. You can submit the request online or through your mutual fund advisor. The request can be made anytime. However, it is recommended that you submit the request when you want to stop the SIP. Submitting a request for stopping SIPs at a later date may not be as fruitful.

21. How to extend the duration of SIP?

You can submit a request through your advisor or online to the fund manager. Or submit a new SIP request when your existing SIP stops.

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