What is a Systematic Investment Plan and how does SIP mutual funds work ?

What is a Systematic Investment Plan and how does SIP mutual funds work ?

SIP or Systematic Investment Plan or SIP mutual fund is one of the most searches by people on google. Many investors want to know about SIPs. Via SIPs you can become millionaires or billionaires by investing small amount monthly/ quarterly/ annually. In this article we’re going to discuss about SIPs in brief & how you can use this tool to create wealth over long-term.

An SIP or a Systematic Investment Plan allows an investor to invest a fixed amount regularly in a mutual fund scheme, typically an equity mutual fund scheme.
Why should you SIP?
One, it imparts financial discipline to your life. Two, it helps you to invest regularly without wrestling with market mood, index level, etc. For example, if you are supposed to put a fixed amount every month in a mutual fund scheme, you need to find time to do it. When you have the time, you might be worried about market conditions and think of postponing your investments. Or you might be thinking of investing more if the mood is optimistic. SIP puts an end.

What are the other benefits of SIPs?
SIPs help you to average your purchase cost and maximize returns. When you invest regularly over a period irrespective of the market conditions, you would get more units when the market is low and less units when the market is high. This averages out the purchase cost of your mutual fund units.

Another benefit, called the eighth wonder of the world by some, is the power of compounding. When you invest over a long period and earn returns on the returns earned by your investment, your money would start compounding. This helps you to build a large corpus that helps you to achieve your long-term financial goals with regular small investments.

How much money do I need to start an SIP?
SIPs are so affordable that you can start with the investment of Rs. 500/- & there is no maximum limits. You can plan a SIP according to your financial goal. Being an advisor, We’ll suggest you to start one SIP for a particular Financial goal, in another words we can say if you’ve 4 financial plan i.e., 1st Child Education, 2nd Child Marriage, 3rd Buying a Car (cost 10 lakh), 4th Retirement Plan. Then it would be good if you start 4 different SIP’s for different plan.

Is SIP flexible?
Yes SIP’s are very flexible. You can increase or decrease SIPs amount accordingly.

Target of Rs. 1 Cr. at the age of 60 @ 18% in 30 years.

For achieving this financial goal you need to invest Rs. 700/- per month.
For more details, kindly click the following link:-

Benefit of Rupee cost averaging:-
With volatile markets, most investors remain confuse about the best time to invest and try to ‘time’ their entry into the market. Rupee-cost averaging allows you to opt out of the guessing game. Since you are a regular investor, your money fetches more units when the price is low and lesser when the price is high. During volatile period, it may allow you to achieve a lower average cost per unit.
Receive more units when NAV is lower, vice versa when NAV is higher….

Investment NAV No. of Units Remarks
10,000/- 20 500 Higher NAV-less units
10,000/- 16 625 Lower NAV-More units.
Average Cost per unit 17.78

• The cost is thus average out as NAV falls.
• Longer the SIP period, better the impact of rupee cost averaging.

Benefits of Compounding:-

Albert Einstein once said, “Compound interest is the eighth wonder of the world. He, who understands it, earns it… he who doesn’t… pay it.” The rule for compounding is simple – the sooner you start investing, the more time your money has to grow.
The longer you invested, the wealthier you can be.
SIP of Rs. 1000/- per month growing @ 12% p.a.*

Period Principal (in lakh) Final Value Growth of Principal (Compounding Effect)
10 Years 1.2 2.3 Almost 2 times
15 Years 1.8 5.0 Almost 3 times
20 Years 2.4 9.9 Almost 4 times
25 Years 3.0 18.8 Almost 6 times
Average Cost per unit 17.78

• For illustration purpose only. These are assumed returns & actual returns may vary.

Don’t delay or discontinue a SIP

Target of Rs. 1 Cr. at the age of 60 @ 15%

Start Age Monthly Investment
25 Year Rs. 700/-
30 Year Rs. 1,450/-
35 Year Rs. 3,100/-
40 Year Rs. 6,700/-
45 Year Rs. 15,000/-

• An early start is good; Every 5 year delay doubles monthly investment.
• Only Rs. 700/- p.m. needed if you start at 25 years.
• For illustration purpose only. These are assumed returns & actual returns may vary.

SIPs make market timing irrelevant

SIPs help you manage the market volatility well. Timing the market can be hazardous to your wealth and health. Instead focus on ‘time in the market’ in the endeavor to create wealth by selecting the best mutual fund scheme to invest.

Studies have repeatedly highlighted the ability of equities to outperform other asset classes (debt, gold, even real estate) over the long-term (at least 5 years) as also to effectively counter inflation.

Other Benefits of Systematic Investment Plans

Disciplined Saving – Discipline is the key to successful investments. When you invest through SIP, you commit yourself to save regularly. Every investment is a step towards attaining your financial objectives.

Flexibility – While it is advisable to continue SIP investments with a long-term perspective, there is no compulsion. Investors can discontinue the plan at any time. One can also increase/ decrease the amount being invested.

Long-Term Gains – Due to rupee-cost averaging and the power of compounding SIPs have the potential to deliver attractive returns over a long investment horizon.

Convenience – SIP is a hassle-free mode of investment. You can issue a standing instruction to your bank to facilitate auto-debits from your bank account.

SIPs have proved to be an ideal mode of investment for retail investors who do not have the resources to pursue active investments.

7 Common myths on SIP’s

Myth#1: Only Small investors go in for SIP
Please note that SIP stands for Systematic Investment Plan (SIP) and not Small Investors Plan. Hence, it is incorrect to be under the illusion and arrogance that SIP, is meant only for small investors.

SIP is for everyone, if you wish to create wealth systematically. Just as a piggy bank and recurring deposit subscribes you to habit of saving regularly with the needed discipline, even SIPs do. And you a better rate of return as against parking money in fixed deposits, recurring deposits and endowment policies offered by insurance companies. By investing your savings in a systematic manner –daily, monthly, quarterly — for a said tenure (period of SIP) helps you build a corpus earning a rate of return, in order to attain your financial goal.

Myth #2: SIP mutual funds are different from lump sum mutual funds
Well many have this delusion. The fact is, there are no special schemes for SIP investments. SIPs are just a mode of investing.

Myth #3: Lump sum investments cannot be done in a scheme, where a SIP account exists
SIP as you know by now, is just a mode of investing in mutual funds. Hence, pumping a lump sum amount to a mutual fund where your SIP exists is possible. So, say you have a SIP of Rs 1,000 going on in a mutual fund scheme and suddenly you have a surplus of say Rs 50,000, you can pump a lump sum amount to your on-going Rs 1,000 SIP account.

Myth #4: I’ll be penalized if I miss one or two SIP dates
While enrolling for the SIP mode of investing you are required to provide a NACH (National Automated Clearing House) mandate from NPCI (National Payments Corporation of India) form along with the common application form. Your SIP details (as selected) are already mentioned in this mandate apart from the SIP form, thus your bank at regular SIP dates keeps debiting the SIP amount in favor of the fund where you have opted a SIP. The start date and end date is mentioned in these forms. You also furnish has your contact details so that you’re update on your transactions. Hence, the question of missing dates usually doesn’t arise.

However, for some reason – say, you haven’t maintained the balance in your bank account – and a SIP installment doesn’t get debited, you simply miss that installment, but the folio / account remains active for further SIPs to debit from the bank account. So, it’s not like the EMI, where you miss an installment; you are penalized.

Similarly, if you’re facing financial crunch, today fund houses also allow you to pause your SIPs for period of 1 to 3 months until normalcy returns. So, a short-term crunch should not be a cause of worry for your SIPs. SIP pause facility is explained at great length in ensuing part of this editorial piece.

Myth #5: Markets are high to start a SIP
Well, if that’s what you think, then you should be starting a SIP immediately. That’s because as the market corrects you would by accumulating more number of units, with every fall in the NAV, thus enabling you to lower you average purchase cost. And, as the markets, post the correction surge once again, you would gain as the yield will work to be higher.

Myth #6: In a tax saver SIP, entire money can be withdrawn after 3 years
In case of a SIP in tax saving mutual funds (commonly known as ELSS, very often a delusion exists that, the entire investment in a tax saving mutual fund can be withdrawn once the lock-in period is over. But that’s not the case!

The fact is: your every installment of SIP should have completed the lock-in tenure. So say if you put in Rs 5,000 through SIP in the month of January 2017, the lock-in period for only 1 installment (i.e. January 2012) will get over on January 2020. While other SIP installments need to complete 3 years as well.
Types of SIP:-

Step-up SIP (also known as Top-up SIP) enables you to increase your SIP amount at regular intervals. This is helpful especially in goal planning, where you say you have a windfall income or bonus and want to invest. So, you can start with a small amount initially and gradually increase the amount you invest. Consequently, as our income increases, so do our expenses. Therefore, increasing your investment level will protect you on rainy days.

Many a times, investors continue the same monthly investment through SIP for over 5-7 years. Though they may have earned good returns on the investment, they would have lost out on earning an additional income had they topped up or stepped-up their SIP. Adding up the SIP amount regularly is an easy way to build up wealth.

To add on, you have an option to have a fixed or variable top-up (Top-up Cap) amount and a Cap Year. You can either set a fixed limit to your top-up amount or keep it variable. Also, you can set a date until when you would wish to continue your top-up facility.

Top-up option must be specified at the time of enrolment. The amount can be as low as Rs 500 and in multiples of Rs 500 only. Further, the top-up details cannot be modified once enrolment is done. Hence, be sure before applying for it. A half yearly and yearly SIP top-up frequency is available for monthly SIP. Quarterly SIP offers top-up frequency at yearly intervals only. If you miss out on informing your top-up frequency it is assumed to be at yearly intervals.

2. Flex SIP
At times if you do not wish to SIP owing to uncertain cash flows, you can opt in for flex SIP (also known as flexible SIP) and still stay invested. With this, you can adjust your installment as you would want. Not only this, you can even opt for a trigger-based option (explained in the following point). For example, if you are rewarded by a bonus of Rs 1,00,000, with the help of Flex SIP, you can allocate the investible surplus to directly into one of the funds of your existing portfolio. This gives you the flexibility to either increase or decrease the amount in any particular month.

3. Trigger SIP
This facility is more viable if you are experienced as it involves some amount of awareness and knowledge.

With Trigger SIP, you can set either an index level, NAV, date or an event. This is to take advantage of any movement in anticipation. For example, if you know a certain kind of Government policy is due next week and that will impact the index crossing a certain mark, you can set it as a trigger date.

Similarly, you can set trigger target for your fund NAV appreciation or depreciation (in percentage terms) or capital appreciation or depreciation trigger.

However, PersonalFN believes this could induce speculative habit and should be avoided. Best is to always have a long-term view in mind to achieve your set of financial goals.

4. Perpetual SIP
Usually when signing up a SIP mandate, you must enter the start and end date. This is for a pre-decided term period say 1 year, 2 years, 3 years, 5 years, etc. And once the SIP matures, many a times investors tend to procrastinate and delay renewal due to operational hassles. In turn, they end up missing few installments, which upsets the saving discipline and affect returns in the long run.

If you leave the end date block blank in a SIP mandate, by default you opt for perpetual SIP. Most fund houses will assume this SIP to continue till 2099, unless you submit/provide a written communication to the fund house. So, once you achieve your goal corpus, you can redeem your funds as per your convenience.

5. Pause SIP
God forbid, but when in a financial crunch or crisis, you can even pause SIP installments instead of stopping SIPs altogether and impeding your path to systematic wealth creation. By doing so you don’t have to undergo the process of re-starting SIPs all over again.

As mentioned before, you can stop SIPs for period of 1 to 3 months until normalcy returns. This will give you the needed relief for those few months under distress.

Here are steps to pause your SIPs…
1. submit the pause form to the mutual fund house (or the AMC) and send an instruction. The form can be downloaded from the mutual fund house’s (or the AMC’s) website or sourced from the Investor Service Centre.

Submit a Bank Mandate.
2. Once the form is submitted, do not forget to instruct your bank to stop the auto debit service or stop the post-dated cheque. If you miss out on the bank’s mandate, they might charge you for dishonour of payment.

Once your pause period is over, ideally, you should resume your SIP. Proactively ensure, that you aren’t jeopardising your long-term financial wellbeing.

Keep in mind that not all mutual fund houses provide the Pause-a-SIP facility. Therefore, it is best to check whether the option is available at the time of registration. Also, bear in mind that pause facility is usually offered only once the whole tenure of your investment.

Although pausing a SIP is option, that provides suppleness to sail through turbulence, avoid pausing (or even cancellations of) a SIP; because in effect it hinders the path to wealth creation and accomplishing your financial goals. Instead, adopt utmost financial discipline and be focused to achieve your long-term financial goals. Engage in prudent budgeting exercise and maintain a sufficient contingency fund, which can act as a protective shield in times of emergency.

Remember, the key to financial freedom is perseverance

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