What is SIP and how does it work in mutual funds?

If you are a first time investor, inculcating the discipline of regular investing can be a little difficult. However, if you have decided to invest in mutual funds to target your life’s long term goals, you can consider starting a monthly SIP in mutual funds.

What is SIP?

Systematic Investment Plan or SIP as it is commonly referred to as in the mutual fund industry, is an investment process that allows retail investors to invest fixed amounts at regular intervals in a mutual fund scheme of their choice. If you really wish to see your money multiply over the years and snowball into a large corpus, SIP can help you get there through regular and systematic investing. If you have surplus capital to invest, you can even make a onetime lumpsum investment. But investing in mutual funds via SIP has its own perks.

How does a Systematic Investment Plan work?

A SIP works just like a recurring bank deposit, only here investors are blessed with several benefits and high liquidity. Understanding how a Systematic Investment Plan is important as it will give investors a clear perspective on what will happen to their money once they start investing. SIPs come in different forms, weekly, monthly, quarterly, six months thus offering absolute convenience for investors. The main purpose behind initiating SIP investments was to give every investor an opportunity to invest in mutual funds and earn capital appreciation. Investors get to choose the SIP sum which they are comfortable investing at periodic intervals (usually every month). However, the SIP sum which the investor decides cannot be lesser than the minimum SIP investment amount stated in the SID (Scheme Information Document). There are some schemes which one can start an SIP with an amount as low as Rs. 500 per month.

Once you decide how much money you want to invest in a mutual fund scheme via SIP and instruct your bank to allow auto debt, every month on a said date the predefined SIP sum is debited from the investor’s savings account and electronically transferred to the fund. Investors are allotted units in quantum with the SIP sum and depending on the fund’s existing NAV (net asset value).

Benefits of SIP investing

Power of compounding is an investment tool that is known to turn your small SIP sums into a large commendable corpus. In mutual funds, the term ‘compounding’ is nothing, but the interest earned on the interest earned from the initial investment amount. When the amount you invested in mutual funds via SIP earns interest and when that interest starts earning interest of its own, compounding is considered to have come into effect. Compounding ensures that you not only earn interest on the amount invested but also gives the earned interest an opportunity to earn interest of its own.

Rupee cost averaging is another investment technique that gives SIP investors an opportunity to benefit from falling markets. Since the equity markets keep fluctuating from time to time, SIPs are designed in such a smart way that to actually take advantage of volatile markets. When the NAV of the mutual fund is low, more units are allotted in quantum with the sum invested. Similarly, when the NAV of the fund is high, less units are allotted. That’s because the SIP sum remains stagnant. Over the long term, through SIP investing investors may receive more units and thus reduce the overall investment risk of investors.

One can even target their life’s long term goals by investing in mutual funds via SIP. Investors can continue investing in mutual funds via SIP till their investment objective is accomplished.

Written by 

Alex Wilson: Alex, a former tech industry executive, writes about the intersection of business and technology, covering everything from AI to digital transformation.