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What Is SIP & What Are Its Advantages?

What Is SIP & What Are Its Advantages?

Systematic investment with ULIPs

They say, “even a soft rope can cut through the stone, working on it gradually.” So is true with investments. Whether you want to accumulate a lot of money, or just want to meet a large financial goal, start investing regularly.

What is SIP?

SIPs are an advanced form of regular investing. The predecessor of SIP was RD or recurring deposit, where you will fix a specific amount to be deposited every month in an RD account. The account will operate for a longer period and offer higher returns to investors.

SIP refers to the systematic investment plan, and like RD, you can decide a fixed sum to be invested regularly in an investment instrument. Now, SIPs offer more customization than RD, as you can decide the frequency and the allocation of the investment.

You can direct your SIP to equity funds, debt funds, balanced funds, liquid funds, gold ETFs or even in a unit-linked insurance plan (ULIP).

For example, you can save Rs. 50,000 every month and you want to create a diversified portfolio. You can start a SIP of Rs. 10,000 each in an equity growth fund, a debt fund, a ULIP, a Gold ETF and a pension plan.

Advantages of SIP:

You may have guessed a few advantages of SIPs for yourself from the definition. But here’s a complete list of advantages SIPs can offer you:

  • You can start small: When you start earning, income is low, expenses are high, and the most common excuse to postpone saving is, ‘my income is too low’. Well, not when you can SIP your way to any mutual fund and many investment schemes.

    SIPs give you that edge if you want to start with just Rs. 1000 you can. For long-term wealth, this is what matters – develop a habit of saving.

  • Start Investing Early: Do you know? “You have a better chance of getting Rs. 1.5 lakhs 10 years later by investing Rs. 850 a month, than starting in the 10th year and investing Rs. 10,000 a month.”

    If you want to achieve bigger financial goals. Don’t wait to start saving great amounts. Start with whatever you have. SIPs help you take advantage of an early start.

    Your earliest savings get the higher benefit of compounding, and as shown in the example above can grow quite a lot over a longer time.

  • Convenient to Continue: With SIPs you can choose your frequency. You can invest monthly or even weekly if your income permits. The best part is that you can customize SIPs to match your income frequency. So, you don’t have to think about your savings all the time.
  • Automate your investments: One of the biggest advantages of SIP is that you can automate your savings to investment transactions. As the thumb rule of saving goes, ‘save before you spend’. You can use the auto-debit mandate to automatically transfer money from your salary account to various investments every month.

    So regardless of whether you feel like investing or not, the money will keep flowing to your investments and towards your financial goals.

  • Benefit from Rupee Cost Averaging: Rupee cost averaging is an interesting development from the SIP mode of investing. As you invest your average cost of investment goes down and your returns stabilise. The longer you keep investing, the better it becomes.

    See ‘How Does SIP Work?’ below, to understand the effect of SIP on your portfolio.

How Does SIP Work?

Here’s an example showing you what happens when you invest a fixed sum into an equity fund every month. The example assumes your monthly SIP of Rs. 10,000 into the equity fund.

If you invested Rs. 1 lakh in the beginning and waited for 11 months for the money to grow, you will still have only Rs. 1 lakh in your portfolio.

But SIPs change the game in your favour. Even though the fund’s NAV returns to its initial value, your portfolio has grown to Rs. 1.06 lakhs.

How SIPs work in your favour

The simple logic behind SIP is when NAV goes up you get lesser units, whereas when the NAV falls, you buy more. SIP automatically takes care of the sweet goal of every investor; i.e. buy at lows.

In scientific language, the weighted average cost of your investment falls below the market average as you buy more units at lower prices. Thus, SIPs help you earn even in relatively stagnant markets.

Note that SIPs work best with auto-debit mandates.

When to Use SIP?

SIPs work best with volatile investments like equity, or with investments where you want to accumulate the asset such as Gold ETF.

So, whenever you are planning to invest in equity markets, try to use SIP mode of investing. Even if you have a large sum you can deposit today, it makes more sense to create a rupee cost average. Invest the large sum over the next few months.

For example, if you have Rs 12 lakh to invest, put it in a liquid fund first and activate a systematic transfer plan (STP). STP acts similar to SIP except the transfer is between funds rather than from your bank account.

Invest 4G plan from Canara HSBC OBC Life, even offers a systematic transfer option to investors looking to invest large sums in equity funds. The plan deposits the entire fund in a liquid fund and then gradually transfers the money in equal instalments to equity fund over the next 12 months.

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