Home » What is a systematic investment plan(SIP) and how does it work?

What is a systematic investment plan(SIP) and how does it work?

What is Systematic investment plan(SIP) and how does it work?

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A systematic investment plan (SIP) in a mutual fund is an investment mode where you get to invest a fixed amount of money monthly, quarterly, or semi-annually.  The amount lets you purchase a certain number of units and you are able to invest in the fund during the high and the lows without having to time the market. The timing of the market is very difficult as one can even invest at the wrong time.

Mutual funds are a smart way to start investing in the stock markets for someone who doesn’t have enough knowledge about the stocks. They collect money from the investors and pool this money to invest in different assets like equity, debt, money market, etc.

People have dreams and to reach their financial goals proper planning is required. They may wish to purchase a car, a house, go on a vacation or fund the higher education of their children. Investing in mutual funds can help them in achieving their goals. Investment in the systematic investment plan(SIP) can be automated by giving instructions to the bank to transfer the money from the bank account to the mutual fund on a fixed date every month.

There are two ways you can invest in a mutual fund; through a lump sum or a SIP. The differences between the two are –

Benefits of investing in SIP-

1) Can start investing with a small amount-

The advantage of investing with a systematic investment plan(SIP) is that you can start investing in small amounts. It can be started with a minimum investment of Rs. 500 every month. This small amount suits investors of any budget. The small amounts grow into big amounts over the years.

2) Power of compounding-

SIP works on the principle of the power of compounding. The power of compounding is the interest you earn on the accrued interest. When you invest a certain sum of money in a financial instrument you earn interest on it and due to the compounding effect, you would also earn interest on the interest.

3) Rupee cost averaging-

Rupee cost averaging is when you purchase more units when the net asset value of the mutual fund is low and fewer units when the net asset value is high. When the market falls you get more units of the mutual fund for the same SIP amount and less number of units when the market rises. The purchasing cost is averaged over the tenure of the investment period.

4) Flexibility –

There is a flexibility that you have by investing in a systematic investment plan(SIP). Unlike the post office products like PPF or even the ULIPs, the SIP is better. The funds can be withdrawn according to your choice. They can be withdrawn completely or partially. The SIP investment amount can be increased or decreased.

5) Stop SIP anytime-

Most of the SIPs don’t charge any penalty if you stop the plan anytime. Many other investment products don’t have this advantage.

6) SIPs bring more discipline to your investments-

Many people are not in a habit to save money regularly. SIPs bring discipline to the investment process. You are required to invest a specific amount every month. This brings more discipline where you are forced to save and due to the power of compounding you get good returns at a later date.

7) Timing of market not required-

When you are new to the market you may not be aware of when to enter the market and what price is right. With a SIP you don’t have to worry about timing the market. When the market is high you get fewer units and when the market is low you get more units. Averaging works out for your mutual fund.

8) Higher Returns-

People who invest in the SIPs are able to get higher returns as compared to fixed deposits or post office schemes. This helps at a time of rising inflation.

9) Convenience-

It is convenient to invest in the SIPs and it is a simple process. The investor has to instruct the bank to auto-debit the SIP amount from the account every month and does not have to worry about manually depositing the amount.

Adapting the SIP to your needs-

The SIPs can be tailored according to your needs. Most people prefer monthly SIPs where the SIP amount can be transferred when they receive their monthly salaries. Other than this a person can invest in the SIPs weekly, fortnightly, quarterly, or semi-annually.

A step-up SIP allows a person to increase the SIP investment amount after a specified period. It can be used to increase investment every year when your salary increases. Most fund houses allow a person to increase the investment amount every six months or annually.

In the perpetual SIP, a fixed amount can be transferred to the mutual fund for as long as you wish. Instruction has to be given to the bank and the money gets transferred regularly at a specified date. Perpetual SIPs are good if your goals are far away into the future like your child’s higher education or marriage or even your own retirement and you wish to create a large corpus.

How to invest in SIP-

The process to invest in SIPs is as follows-

  • Set your financial goals.
  • Deicide the investment horizon.
  • How much risk you can take.
  • Your mode of investment- online or offline.
  • Submit your KYC documents.
  • Select the fund to invest.
  • Select the SIP frequency.
  • Submit the application.

A systematic investment plan(SIP) is a simple and cost-effective way to invest in a mutual fund and you can invest a fixed amount every month. The best thing is that you don’t have to wait for a particular time to invest and you can choose any date of the month. When you invest in mutual funds through SIP and keep the fund for a long period of many years the power of compounding comes into the picture and you can accumulate a great amount of wealth.

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