Blog

What is SIP in mutual funds?

SIP (Systematic Investment Plan) is the most popular mutual fund investment method.

In this blog post, we aim to educate our readers about SIP, the idea behind SIP and have a look at the advantages of SIP. By the end of this blog post, you will truly understand SIP and know everything a mutual fund investor must know about SIP. So, let’s go!

What is SIP?

SIP, as already mentioned, is a mutual fund investment method.

It is an automated method of investing in mutual funds. You initiate an SIP and then it goes on for the number of months you want it to go on for. This is predecided or you can decide to discontinue an SIP mid-way as well.

Here the questions one needs to answer while setting up an SIP –

Which fund scheme?

You need to decide up on which fund you would like to invest in via SIP. This is generally an equity mutual fund. You can read more about the types of equity mutual funds here.

What will be the frequency?

It could be monthly or quarterly. Most people earn their salaries on a monthly basis and hence once a month is the most common frequency people choose for SIP.

How much amount?

You are also supposed to decide upon the per fund scheme per month amount. Meaning, if you want to start an SIP in 2 fund schemes – you need to decide how much you want to invest in each of the schemes every month/quarter.

Why SIP? (Pros of SIP)

While there a number of reasons why SIP is so popular, the broad advantages of SIP are two –

Cost Averaging

This is a simple yet powerful idea.

The capital markets are very volatile – there millions of market participants who act in a way to make profit for themselves. Think of a shopping mall with millions of prospective buyers and sellers!

This brings in a lot of uncertainty and it is considered impossible to know when you will be able to find stocks or mutual fud units at cheap prices. This is a problem because to earn returns you need to be able to buy at low prices and sell at high prices – if prices cannot be accurately predicted then equity investing will not yield returns!

Cost averaging suggests to not worry about the volatile market movements – it asks you to ignore the price while investing in mutual funds. Since you are not going to be able to predict low prices, why waste energy in such an exercise.

This sounds ridiculous, doesn’t it?

But the idea starts sounding acceptable when one realizes that the long term trend of the market is upwards. Meaning, you check the level the market is at today and check the level the market will be after 10 or 15 years. You are highly likely to find the market at a substantially higher level after 10 or 15 years!

Let’s have a look at the BSE Sensex graph (it serves as a good proxy for equity mutual funds in this discussion of ours) –

You can see that over short periods like 1-3 years from a point, the markets may be up or down. But over longer periods like 7-10 years, the markets are almost always up.

As we can see from the data below –

This historical trend loosely validates the logic of SIP – invest without the worry of current market levels, the average buying price of your investments will be less than the selling price 10-15 years later.

Additionally, the longer you stay, the greater is the chance of earning a return closer to the expected return. This is better explained by the concept of rolling returns and standard deviation.

Disciplined Investing

The best investment practices are focused towards elimination of human biases.

Cost averaging eliminates the human biases of greed (when the market is doing pretty well) and fear (when the market is losing point every day).

Another natural defect humans have is to spend if you have easy access to money.

This is dominantly observed with people with fewer responsibilities – in their 20s.

When people are new to earning money, they are new to expenses and savings, and more often than not don’t concentrate on saving!

Readers would be able to resonate when I say that if you see that your bank balance is lower than you expect then you won’t spend on something you don’t need or if the purchase can be delayed with no considerable impact on price.

A good strategy to keep your balance artificially low is to segregate your savings and put them in a place that is not as easily accessible as a debit/credit card.

Equity mutual fun SIPs provide a great option to stash away your savings while ensuring that they grow at a rapid pace!

Withdrawing money from equity mutual funds is straightforward but the money takes time to hit your bank account – up to 3 working day. This aspect is especially helpful to avoid the temptation of spending the invested money.

Goal Based Investing

If you can assume a rate of return, your SIPs will help you forecast the corpus you can create in 5-10-15 years!

If you have a financial goal such as purchase of a car or a house or financing your child’s education or marriage, you can find out how much money you need to achieve these financial goals.

In the initial stage of your working life, it is not easy to plan for capital intensive goals with a lumpsum investment.

For example – Let’s say someone has recently started working at 22 and hopes to be able to pay the down payment of the house he plans to buy at 30.

The down payment he will require in 8 years is estimated to be Rs. 25 Lakhs.

Even if we assume that his equity lumpsum investment will give him a 12% return over the 8 year period, the person needs to invest Rs. 10.1 Lakhs today!

This is especially difficult for someone who has just started his career.

On the other hand, an SIP of Rs. 15,600 will create a corpus of Rs. 25,000 for the person. This seems way more feasible than a lumpsum investment of Rs. 10.1 Lakhs for a 22-year old!

SIP makes goal-based investing easy!

However, SIP is not all rainbows. It suffers from a few disadvantages which will be discussed in a future blog.