WHAT IS AN SIP? HOW DOES IT WORK?
One of the most common questions asked by novice investors is what SIP mutual funds are. If you are one such investor, you need not need to look further. SIPs have gained quite a reputation in the investing world and for all the good reasons. In this article, we will understand what an SIP investment is and how does it work.
What is SIP?
SIP or Systematic Investment Plan is nothing but a means for investors to invest their money in mutual funds. Several investors confuse SIP as an investment product. However, it is rather an investment tool that allows investors to invest in investment products such as mutual fund investments. When you invest in mutual funds via SIP, you invest a fixed sum of money at regular intervals in your desired mutual fund schemes for a fixed duration of time. The periodicity of the intervals can be yearly, monthly, weekly, semi-weekly, or daily, according to the convenience of the investor. The most common periodicity interval chosen by investors is daily. SIPs offer wide array of flexibility to investors – an investor has to predetermine their investment amount, type of SIP, types of mutual funds they wish to invest in, duration of the investment, periodicity intervals, etc. SIPs are accessible to all investors as the minimum amount to invest in mutual funds via SIP is just Rs 100 per month, making it accessible to investors with daily wages as well.
How does SIP work?
Before we understand how to invest in SIP, it is important to know the mechanics of SIP investments. Let’s understand the working of an SIP investment with the help of an example. Rita earns Rs 50,000 per month and wishes to invest around 10% of her income in SIP mutual funds on a monthly basis. As a result, Rita started investing Rs 5,000 in ABC mutual fund scheme since Feb 2008. Every month, Rs 5000 would be automatically deducted from Rita’s account and the same amount would be used to purchase mutual fund units at the prevailing NAV (net asset value) of the fund. This Rs 5,000 that Rita invests regularly and systematically each month would turn into a sizeable corpus after a period of time. This is due to the power of compounding. Also, as SIP investments ensure regular investments in the desired mutual fund schemes irrespective of the market condition, Rita would end up investing in both types of market cycles – bearish and bullish market phase. As a result, Rita would end up accumulating higher number of ABC mutual fund units when the markets and low than when the markets are at its peak and vice versa. This would help her to average out the total cost used to buy the mutual fund units. This concept is widely known as rupee cost averaging.
Between Feb 2008 to Feb 2018, she would have made a total of 120 SIP installments of Rs 5,000 each into the ABC fund. As on Feb 2018, the total capital invested would stand at Rs 6 lacs (120 * Rs 5,000). If you assume an average rate of interest at 12% per annum, the total SIP investment would have grown to Rs 11.6 lacs, which is almost double the amount invested by Rita. To do all these calculations, you can use an SIP return calculator for the same, which can make your work easy and hassle-free. Happy investing!