SIPs Demystified: A Beginner's Guide to Systematic Investment Plans

Many new investors often confuse mutual funds with SIPs. While mutual funds are investment products, a Systematic Investment Plan (SIP) is simply a disciplined way to invest in them regularly.
 

Introduced in India in the late 1990s, SIPs have become one of the most popular investment methods. The Association of Mutual Funds in India (AMFI) further boosted their popularity in the early 2000s through awareness campaigns.
 

This article aims to help both new and existing investors understand SIPs and their advantages.

What is SIP?

An SIP is a method of investing in mutual funds through regular contributions rather than placing a lump sum deposit. You can set up an SIP for as little as Rs. 100 per month with automated monthly deductions.

SIP is popular because it ensures disciplined investing. In order to maximise returns, this long-term investment strategy emphasises starting early. "Start Early, Invest Regularly" is the key to long-term results.
 

How does an SIP work?

SIPs work by automatically debiting your bank account and investing the amount in the mutual fund of your choice. As soon as your deposit is made, you receive units of the mutual fund scheme you invested in. The number of units that you have invested depends on the current Net Asset Value (NAV) of the particular scheme.
 

The SIP mutual fund allocates additional units with each instalment. With the same SIP amount, you may buy fewer units when the market is high and more units when the market is low since the NAV of the scheme keeps on changing.
 

There are two underlying processes that explain how SIP works.
 

Power of compounding

When you invest regularly, your returns start earning returns as well. Even small monthly investments can grow into large sums over time. It also implies that the compounding effect is greater as you stay invested for a longer period.
 

Rupee cost averaging

It means that you purchase mutual fund units at different prices over time. With SIPs, you invest a fixed amount regularly, so when prices are low, you get more units, and when prices are high, you get fewer units. In this way, you minimise the risks of investing a large amount at the wrong time and balance out the overall cost of your investment. This helps you remain invested during both ups and downs of the market without having to time the market. With this strategy, you can expect better average returns over the long term and a smoother investing process.
 

Here is the SIP example:
 

During the course of six months, the investment through SIP acquires 300 units at a cost of Rs 12 per unit. A lump sum investment yields only 240 units, with a per-unit cost as high as Rs 15.

When to invest in SIP

You can start investing in SIPs at the following times:
 

1. Early age

Investing in SIPs in your 20s or 30s leverages the power of compounding. With adequate time, you can accumulate substantial wealth for your future needs.
 

2. Mid-life start

In the 40s or 50s, you can consider SIPs to help you reach your financial goals or secure a comfortable retirement. Even though compounding takes more time, disciplined investing can yield meaningful results.
 

3. Stable income

To comfortably commit to contributions, ensure you have a steady income source before beginning a SIP. To invest stress-free, assess your financial situation to ensure surplus income after essential expenses.
 

4. Beginning of the month

To promote financial discipline and avoid delaying investments, start SIPs at the beginning of the month. By consistently investing early, rupee cost averaging can potentially reduce your overall investment costs.
 

5. Special occasions

If you receive lump sums like bonuses or inheritance, invest them in SIPs to make the most of your money. Start an SIP to grow wealth during special occasions, such as birthdays and anniversaries.
 

Types of SIP

Different types of SIPs are available to meet different financial needs. The following are the different types of SIPs:
 

Top-Up SIP

In a top-up SIP, you increase your investment amount periodically, for example, every year or every six months. It's best suited for individuals whose salaries increase over time. You can invest more as you earn more, and your wealth will increase faster.
 

Flexible SIP

With flexible SIPs, you can select the amount you wish to invest every month. You can vary the amount based on your cash inflow, like getting bonuses, facing unexpected expenses, or managing monthly budgets. It is appropriate for individuals who have irregular incomes.
 

Perpetual SIP

Fixed-tenure SIPs run on a specific tenure, but perpetual SIPs never end. You can continue to invest as long as you desire and stop when you've achieved your target. It is best for long-term investors who do not wish to let their investments automatically end.

What are the benefits of investing in a Systematic Investment Plan?

The following are the key benefits of investing in SIP:
 

1. Disciplined investment

SIPs are regular investments into mutual funds of your choice, usually every month. The advantage is that your money grows over time through a market-linked¹ investment that can outpace inflation. Even though traditional options like recurring deposits also encourage saving, mutual funds offer higher returns that most fixed-income instruments may not.
 

2. Cost-effective

SIPs are a budget-friendly way to invest. You can build your portfolio gradually with small, regular contributions instead of a large lump sum. In this way, mutual fund investing becomes more accessible to a wider range of investors and reduces financial strain.
 

3. Power of compounding

In compounding, your investment returns generate additional returns. Your regular investments, along with their returns, are continuously reinvested with SIPs. Eventually, this helps in boosting your overall gains. This compounding power works best when you stay invested for long term. You can maximise wealth creation by starting early and staying consistent with your SIPs.
 

4. Flexibility

Flexibility is one of the key benefits of SIPs. SIP instalments are not limited - you can continue investing for as long as you wish. With lump sum investments, you're usually committed to a large amount at once without the option of spacing it out or adjusting it as needed.
 

5. Lower risk

Market volatility is mitigated by the rupee cost averaging strategy employed in SIPs. During downturns, fixed investments buy more units, and during upswings, fewer units are bought. It reduces the overall risk and provides a more stable investment journey by lowering the average cost of the units purchased.
 

6. Convenience

Another major benefit of SIPs is their convenience. You don't have to constantly track the markets or do in-depth research to time your investments. All it takes is a one-time setup once you've selected a mutual fund. By setting up standing instructions with your bank, your SIP amount is automatically deducted each month, ensuring consistent investing without any manual effort.
 

7. Lower investment capital

Investing in SIPs is accessible to a wider range of investors because it can be started with a relatively small amount. The lower minimum investment requirements allow you to build your portfolio with modest contributions. With this gradual approach, wealth can be accumulated over time without requiring large capital.
 

8. Diversification

Diversification is one of the built-in advantages of SIPs. Investments are spread across a variety of assets, reducing overall risk. By minimising the impact of underperforming components of the portfolio, you can protect your wealth and achieve a better growth rate in the long run.
 

9. Professionally managed investment

By investing through SIPs, you let experienced professionals manage your money. They help you navigate market ups and downs strategically, maximising growth opportunities and effectively managing risks.
 

10. Passively managed funds

Passively managed funds, like index funds or exchange-traded funds (ETFs), can also be included in a SIP.  These funds follow particular market indices and try to mimic their performance rather than actively choosing stocks.  Because passively managed funds can offer broad market exposure and have lower fees, SIP investors frequently select them.

How to invest in Systematic Investment Plans?

Here's how you can invest in SIP:
 

Step 1: Decide on your investment goals

Decide on your financial objectives and your risk appetite. It will guide you in choosing the correct type of investment.
 

Step 2: Choose a mutual fund

Choose a mutual fund that best aligns with your objective and risk level. Look at its past performance, consistency, and rating before investing.
 

Step 3: Create your SIP

Finish the KYC process, link your bank or Demat account, and fill in the SIP application to begin investing.
 

Step 4: Select the investment mode

You can begin your SIP conveniently through online or mobile banking platforms.
 

Conclusion

Investing in mutual funds through Systematic Investment Plans (SIPs) is a disciplined and easy way to build long-term wealth. By investing small amounts regularly, investors can benefit from compounding and rupee cost averaging, increasing wealth steadily and reducing market volatility. Once you have invested in SIP, you need to monitor the performance of every fund. You can use an SIP return calculator to compare and choose the ideal SIP investment plan. Remember that no two people will have the same financial goal; hence, strategise and select your own.