SIP – Systematic Investment Plan and it works

What is SIP and how it works

SIP (Systematic Investment Plan) is a systematic way of investment on a monthly basis in a smaller amount for a long duration. It is similar to a recurring deposit a/c of a bank. Where you deposit a small amount every month for a certain duration and get a sum of the sizable amount at the end of the maturity period. The amount you deposit in SIP in invested into equity market through a mutual fund company by pooling the funds of a large number of SIP investors.

How it works and grow
Your every investment is converted in proportional units which are credited into your account with the mutual fund company. The profits earned by the mutual fund company through the investment of such pooled funds of investors are divided/converted into small units proportional to your periodic investments. The net asset value (NAV) is declared by the mutual fund company on a periodic basis. You have an option to redeem the units of your account into real money either at the maturity or before it as per the rules prescribed by the mutual fund company. The value of real money at the time of the exit will vary according to the NAV at the time of exit. Thus SIP allows you to invest in a mutual fund by making monthly investment instead of one-time investment in the money market. For example, in SIP you can 10 periodic investment of 500/- in mutual fund in place of investing of Rs. 5000/- lump sum.

SIP thus buys mutual funds within the reach of an average person, as the investment is made on a very small scale. Though investment of small amount may seem negligible at initial stages and may not appeal too much, it enables the investor to develop a habit of saving. If these habits continuous over the years, it will grow to give handsome returns.

For example, a monthly SIP of Rs 1000/- at the rate of 9% would grow to Rs. 6.69 lac in 10 years. Even for cash-rich investors, SIP reduces the chance of investing at the wrong time and worries of wrong investment decision. The real benefits of a SIP can be realized or seen by investing in lower levels.

The main benefits of investment in SIP can be summarized as under.

1. Discipline
The ground rule to build your wealth is to focus on long term financial goods, invest regularly and maintaining disciplined investment pattern. Your disposable income would not be affected by parting smaller amounts every month as compared to invest a heavy amount one time.

2. Power of compounding
According to financial experts, one must start early savings in life to get the real benefit of compounding. For example, person A started investing in Rs. 10,000 per year at the age of 35 and person B started to invest the same amount at the age of 30. When both attain the age of 60 years. respectively, A will build a corpus fund of Rs. 7.89 lac at the rate of 8% compounding whereas B will have Rs. 12.23 lac. So the difference of Rs. 50,000 due to late starting of saving would result in a difference of Rs. 4 lacs to end corpus fund. The longer this period of compounding, the higher is the return.

 3. Rupee Cost Averaging
This happens when you invest in equities. When you invest the same amount in equity fund at regular intervals over time, you can buy more units when the price is lower, reducing the average cost per share over time. This method is called “rupee cost averaging”.

This method protects the investors from market ups and downs while using the sensible and long seem investment planning. Therefore it reduces the risks of an investment in a volatile market. In SIP your average cost of investing comes down since you go through both up & down trends of the market.

4. Convenience
The investment method of SIP is very convenient. Only you have to sign a mandate to the mutual fund co. giving your bank account details. The account balance should be sufficient to meet the SIP amount. Further, you will also get regular statements from the mutual fund company giving details of units and their net asset value (NAV).

5. Other advantages
There was no entry or exit load on SIP investments, capital gains where ever applicable, are taxed on first in and first out basis.

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