Systematic Investment Plans (SIPs) Decoded: Market Experts Share Some Fundamentals You Didn't Know About
A Systematic Investment Plan, or SIP, is a method of investing in mutual funds, wherein an individual can contribute a small amount regularly - on a weekly, monthly or quarterly basis - to build the desired corpus over a period of time. According to financial experts, approaching mutual funds through the SIP route is a disciplined way of investing - one that helps in long-term wealth creation through compounding returns as well as protection through rupee-cost averaging. Depending upon the timeframe selected by the investor, the money is deducted from the designated savings account at regular intervals. (Also read: 10 Big Investment Mistakes You Should Avoid)
How does a mutual fund SIP work?
An SIP allows investor to contribute regularly to the selected mutual fund scheme based on one's financial goal, time horizon and risk profile. "A mutual fund is pooled by a large number of investors and is managed by fund managers who invest in equities, bonds, money markets and other securities. The total money pooled is divided into units," explains Ritesh Ashar, chief strategy officer, KIFS Trade Capital.
Through an SIP, an investor pays a fixed amount over a specific time interval - such as weekly, monthly or quarterly. "The investor can purchase more units when the price is lower and less units when the price is high," he says.
(Also read: Five Investment Options That Offer Safe Returns)
What are the benefits of investing in SIPs?
According to Archit Gupta, founder and CEO, ClearTax, if an investor parks a big amount in the markets directly, there is always the risk of losing out a major portion of the investment in case of a crash.
"On the other hand, with SIPs, the money is spread over time and only some parts of the entire investment is likely to face the market volatility."
"Rupee-cost averaging"
"An SIP allows an investor to put the money at different levels of the market cycle. When the market is low, the fund manager buys more units and can sell high when the market is at its peak. It helps in reducing the per-unit cost of buying the units. This phenomenon is known as rupee cost averaging," he explains.
How can you choose the right SIP?
According to Gautam Kalia, head, Investment Solutions, Sharekhan, a subsidiary of BNP Paribas, choosing the right SIP involves zeroing down a mutual fund, the investment amount, the frequency and the tenure. "Choosing the fund and tenure is based on the financial goal which depends upon the return expectation and risk appetite. The investment amount and frequency depend on investible surplus available as well as the nature of the cash flows," he adds.
"The investor can opt for a large cap (fund) if they want to bare low risk. For a high reward ratio, he/she should invest in mid- or small-cap funds," opines Ritesh Ashar, chief strategy officer, KIFS Trade Capital. "There are high liquidity funds available as well in the market. Hybrid funds are also available for investors who want to have a balanced portfolio. Individuals should invest in funds which give high and consistent returns."
SIP allows investors to opt for a tenure between six months and 99 years. In the words of Brijesh Parnami, CEO, Essel Wealth Services, "(The) higher the tenor, higher is the growth. This is the fundamental principal. However, all the investments in mutual funds are subject to market risks."
How much money should you invest in an SIP?
An SIP can be started with an amount as low as Rs 500. "However, the amount of the SIP should be based on the target amount and investible surplus," suggests Lav Kumar, head product and business development, LIC AMC. There are various types of SIPs available in the market and a basket can be created with various funds depending on one's risk appetite and financial goals.
A salaried employee should ideally save and invest at least 20 per cent of the monthly salary for future, advises Amar Pandit, founder of Happyness Factory.
How to plan your savings for an SIP investment?
According to financial experts, an SIP should always be goal-oriented. Rachit Chawla, founder and CEO, Finway, cites the following example to explain this:
"Suppose a car is priced at Rs 6 lakh now but five years down the line, it will cost 20 per cent more considering the inflation. So the goal becomes Rs 7.2 lakh. Now according to your active income or pocket, you have to divide that amount in such a way that your SIP gets auto deducted so that you can buy that car after five years."
"It is always advisable to have multiple SIPs for different goals of life. For retirement I would suggest debt, and for wealth increase equity is the best option. One should divide the goals of life to buy something, for retirement, for financial freedom, and wealth maximistion. For those goals backward SIPs have to be done," Mr Chawla adds.
How to customise SIPs?
Investors can customise an SIP in a way that they put money into any other investment product. "Many fund houses allow...a monthly, bi-monthly, fortnightly and, in some cases, daily frequency as well. The amount of investment can also be altered through step-up SIP and alter SIP or perpetual SIP," explains Mr Kalia of Sharekhan.
Step-up SIPs allow investors to increase the amount during the tenure. "For instance, if Ram is running a Rs 5,000 SIP in a particular fund, he can set it up so that the SIP amount increases by Rs 2,000 every year. This way, the SIP becomes one of Rs 7,000 in the second year, Rs 9,000 in the third year, and so on," ellaborates ClearTax's Mr Gupta.
An alert SIP, on the other hand, sends an alert to the investor to buy more when the markets are down.
In case of the perpetual SIPs, the investor doesn't have to choose an end date for the plan. Once the goal is met, the investor can stop the SIP by sending a written communication to the fund house. Some fund houses also allow investors to name the SIP as per the goal that he/she wants to achieve.