What is SIP?

Systematic Investment Plan, commonly referred to as an SIP, allows you to invest regularly a fixed sum in your favorite mutual fund scheme/s. In SIP, a fixed amount is deducted from your savings account every month and directed towards the mutual fund you choose to invest in.

How does a SIP work?

Through SIPs you can invest in any kind of mutual fund, which helps you create wealth over the long term. Here, generating returns and creating wealth are not the same thing. Investing in fixed deposits only helps you in generating returns. But if you want to create wealth, you can invest in SIP mutual funds. And this amount is automatically deducted from your bank account at the interval at which you choose to invest.

Let’s suppose, you invest a certain amount in a monthly SIP and have automated your deduction date as 5th of every month. So, this amount will be automatically deducted from your bank account on the 5th of every month to be invested on the selected mutual fund.

As an investor, the next question you might ask is why should I invest in SIP?

Benefits of investing in SIPs

Power of compounding:

Under the power of compounding, you not only get returns on the money which has been invested but also on the gains. And this way you are able to create a great amount of wealth over a period of time. Let’s suppose, in one year, you have invested Rs 1 lakh in a mutual fund. Its one year return is 15 percent. So by the end of the year, this amount will be Rs 1 lakh 15 thousand. What power of compounding does is, in the next year (assuming the rate of return if 15 percent), it will provide the return on Rs 1 lakh 15 thousand, instead of your original investment of Rs 1 lakh. So, this way, in the second year, you will be getting a return on money that you have invested, and also on the gain from the previous year. By the end of the second year, the amount would be Rs 1 lakh 32 thousand.

Disciplined investing:

Investing through SIPs brings a discipline in your investment approach. Ace investors often recommend that your day-to-day financial activities should be fashioned around a simple formula of Earning – Savings = Expenses.

But, if you invest in SIP, you will be compelled to follow a disciplined investment regime. If you are aware of what your expenses are, you will make a habit of spending within the budget. Within that, first you will save and then spend. If you fashion your financial activities around this, i.e. first save and then spend, you will never face any financial hardship as you are following a disciplined investment approach. Maintaining regularity in your investment approach helps you achieve your financial goal or financial objectives.

Rupee cost averaging:

If you are investing a fixed amount on a regular basis in a SIP, in the time when the markets are bearish, you will be allotted more units for your investments. Meanwhile when the markets go up, the number of units that will be allotted for your investments will be much lesser. That is, when the markets are down you are buying more units and when the markets are at the peak, you are buying less. This way your cost gets averaged out.