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SIPs for Dummies | Meaning of Systematic Investment Plan

20 May 2016
A SIP involves making systematic investment of small amounts for a long period of time. This plan is the simplest option for individuals seeking wealth creation with risk mitigation.

A Systematic Investment Plan or SIP is an investment tool that helps ordinary individuals invest amounts as small as Rs. 500 per month in a slow and steady manner in equities, debts, and other asset classes. As the name suggests, these plans focus on generating steady returns through systematic investments as opposed to high-value big-ticket investments done at irregular intervals.

Related: Investment Options- Thinking Beyond the Obvious

How do SIP’s Work?

Most SIPs require a minimum investment of Rs. 500 per month. This amount will be used to buy units of one or multiple mutual funds of your choice. So, if you choose an equity fund with Net Asset Value of Rs. 10 per unit, Rs. 500 will be deducted from your account and you will buy 50 units in the first month. In 12 months, you would have invested Rs. 6000 and would have purchased 600 mutual fund units at Rs. 10 per unit.

As the underlying asset, which in this case is the equity market, performs well, the NAV of your units will increase. So, an increase in the NAV to Rs. 12 will result in your investment growing to Rs. 7200. You can redeem the units i.e. sell the same at the current NAV and recover your investment at your discretion.

Related: Equity Linked Savings Schemes: High returns tax savings (Part I)

Why SIP?

The best investment strategy is one that maximizes chances of wealth creation with minimal risk of loss of capital. However, high-risk wealth creation options such as equities can be risky. On the other hand, safer options may not offer attractive returns. SIPs can help you bridge the gap and create an investment strategy where you enjoy significant long-term returns even in volatile markets.

Secondly, this simple investment tool allows you to make slow and steady additions to your investments over a long period of time. Making big ticket investments may seem very attractive. However, most individuals find it impossible to allocate their bonus payments towards long-term investments in a disciplined manner. On the other hand, allocating Rs. 500 or Rs. 1000 per month will be easy even for somebody who has just started his or her first job.

Thirdly, SIPs allow you to reduce the average cost of your investments over the long run. Investing Rs. 50,000 in the equity market or in debt instruments in one go will put you at risk of losses due to market volatility.

Related: ULIPs vs Mutual Funds- Where to invest?

Let us presume the NAV in the above-mentioned example falls to Rs. 5 per unit in the second month. Now, you can buy 100 units without increasing the minimum investment amount. You will now have 150 units purchased at an average cost of Rs. 7.5 per unit.

Over the long run, SIPs can help you take advantage of downturns in the market to maximize your chances of earning very high returns in the future. In any case, investing small amounts will ensure you don’t lose a lot even when the market is volatile.

Fourthly, SIPs help you enjoy the benefits of compounding. You can reinvest the dividends paid by the mutual fund company to buy more units. Investing Rs. 1000 per month for 15 years i.e. Rs. 1.8 lakhs and earning conservative returns of 10% per annum will fetch Rs. 4.2 lakhs presuming the returns are compounded monthly. Invest Rs. 5000 per month and your Rs. 9 lakhs investment will grow to more than Rs. 20 lakhs in just 15 years.

Related: Give yourself the gift of compounding

A SIP is a smart option for beginners and small investors who want steady returns, minimum stress on cash flow, low costs, flexibility to increase or decrease investments, freedom to sell units when requiring cash, and the option of reinvesting dividends for higher returns.

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