A systematic Investment Plan or SIP is a way of investing in assets such as mutual funds. Suppose you want to invest in a mutual fund. You can either buy the units you desire in a single payment, called a lump sum investment, or you can take the SIP route and commit to making regular and fixed payments over a time period. This approach is what sets SIPs apart and makes them popular in the world of investing. With SIP, investing becomes accessible to everyone, regardless of the size of their investible surplus. You don’t need to have a large sum of money upfront to get started. You can invest small amounts regularly and make your wealth-building journey easier without putting a strain on your current finances.
Let’s understand why every wealth planner recommends SIPs as the foundation of one’s long-term investment strategy.
Consistent Investing
Often, new investors or young adults struggle with maintaining discipline when they start investing. This is because the world of finance can be overwhelming to newcomers. It’s easy for them to get swayed by emotions or distracted by short-term market fluctuations. When you choose to invest through an SIP, you are committing to invest an amount you are comfortable with on a regular basis, such as monthly or quarterly. The amount you select is automatically deducted from your linked bank account on the predetermined date. So, one can say SIPs instil a sense of financial discipline and consistency, which ultimately makes it easier for you to stick to your investment plan and achieve your long-term financial goals. This consistency also enables you to take advantage of rupee cost averaging, which we’ll discuss next.
Rupee-Cost Averaging
From Rupee cost averaging comes the concept of rupee cost averaging. According to the concept, investors regularly invest a fixed amount of money in an investment, regardless of market conditions. Rupee cost averaging thus helps investors average out the cost of investment over the long term, and that’s why the last part, ‘regardless of market conditions’ is important. Often, investors are tempted to time the market and try to predict when to buy low and sell high to maximise their returns. With rupee cost averaging, one doesn’t have to worry about timing the market.
For example, when the market is down, the NAV of the mutual fund and thus the price of its unit is low. When the price per unit is low, you’ll be able to buy more units with the same amount of money. When the NAV is high, you won’t be able to buy as many units for the same amount. Indeed, it makes sense to only buy the units when the NAV is low. But here’s the thing, trying to predict the market can be risky. When you are making consistent investments through SIP, you’ll buy some units at low prices, and some at high. Rupee cost averaging states that over the long-term, this total investment cost will average out, and you won’t have to play the unreliable and risky game of ‘predict the market’.
Harnessing Market Volatility
You may have heard the phrase ‘Mutual Funds are subject to market risk.’ Market risk comes from fluctuations in the market caused by various factors such as interest rates, commodity prices, equity prices, currency, and more. This is also called the volatile nature of the market. When you are investing in mutual funds, you have to deal with this volatility. When people see a downtrend, often they get scared and anxious and pull out of their investments. This kind of short term thinking is wrong and very harmful for wealth creation.
By investing through SIP, investors can avoid the pitfalls of short-term thinking. Not only does it allow you to stay disciplined and take advantage of rupee cost averaging, but it also keeps you focused on the long-term and helps you avoid impulsive decisions, which is pivotal for wealth creation.
Also Read: How to Invest in SIP?
Flexibility and Convenience
Another reason why SIPs are becoming so popular among Indians is the flexibility they provide. Earlier, people used to believe that investing is something only rich people can do, but that’s wrong. Historically, yes, to make a meaningful amount of money through returns, one would have to invest large sums initially. But SIPs have changed the game. Now people can start investing in assets such as mutual funds from as low as Rs. 500.
This flexibility has allowed investors with modest income to take part in the financial markets and participate in wealth creation. That’s not all. As the individual’s financial situation changes, they can even change the investment amount online, anytime. Doing this over a number of years can help amass a sizable corpus due to the power of compounding interest.
SIPs are also convenient and accessible. Everything can be done online. You can start the SIP, select the amount and date you are comfortable with, and vary the amount as per your preference. The amount you select will be automatically deducted from your bank account so there is no need for you to manually do anything. If you face some unexpected expenses and need to temporarily pause your SIP, you have the flexibility to do so as well.
Tax Efficiency
When your financial goal is wealth creation, the importance of tax planning cannot be ignored. With the help of a tax planner, you can legally minimise your tax liabilities and retain as much of your hard-earned money as possible. One way to reduce your overall tax liability is by investing in tax-saving mutual funds, such as Equity Linked Savings Schemes or ELSS. Under Section 80C of the Income Tax Act, ELSS provides tax benefits of up to Rs. 1.5 lakh to investors.
They come with a lock-in period of three years, however, which in fact is the shortest maturity period among other tax saving schemes such as the Public Provident Fund, National Savings Certificate, and National Pension Scheme. Another huge advantage ELSS offers is wealth creation. While other tax saving instruments provide modest returns, ELSS returns can be potentially huge. This is because ELSS invests primarily in equity and equity-related instruments. When one invests in equity they are taking on a high level of risk, but over the long-term one can ride out the short-term volatility and make significant gains.
Psychological Benefits
Apart from making you more financially disciplined, SIPs also help you overcome emotional biases. When you are in it for the long run, you have to learn to be patient and assess the current market situation with a calm and level head. There will be fluctuations in the market, that much is inevitable, and while you shouldn’t be impulsive and redeem quickly, you also shouldn’t overshadow the importance of monitoring your investments. Yes, your SIP gets automatically deducted every month, but you have to monitor factors like the performance of the fund and the fund manager’s decisions, to make sure their decisions align with your financial goals.
You may be confused reading this, on one hand, ignore the market and keep making the SIP, and on the other, monitor your investment and withdraw if needed. Truth be told, this is indeed a fine line, one that takes some time to navigate. With experience and help from a financial planner, you’ll be able to make unbiased and informed decisions, and not act on emotions and impulses. As you’ll make consistent contributions, your habit will form and your growing wealth will give you confidence in your commitment and decision-making.
Long-Term Wealth Creation
One of the biggest reasons why SIPs are ideal for wealth creation is compounding interest. Let’s understand how it works exactly. When you make an SIP contribution, you earn a market linked return. Unlike the interest of a bank FD, this return gets reinvested back into the SIP, thus increasing the principal amount on which future returns are calculated. This means the interest you earned will also earn interest in the future. This reinvestment process creates a snowball effect which allows your investment to grow exponentially. So, one can say that compound interest is the interest earned on interest.
One of the biggest driving forces behind compound interest is time, so one should get started on investing as soon as possible. Because SIPs offer the flexibility of starting with an amount as low as Rs. 500, they allow investors to begin their investment journey early and take maximum advantage of long-term compounding.
Risks and Considerations
There are different types of risks associated with SIP. For example, when you are doing your research about different mutual funds, you’ll come across a risk o metre in the fund’s factsheet. This metre will show you the level of risk associated with the scheme, from high to moderate to low.
For example, an equity mutual fund can give potentially very high returns, but there is also a high level of risk associated with it. On the other hand, debt mutual funds are safer but also give low returns. Investors who want to take on a moderate level of risk for moderate returns can opt for hybrid mutual funds, which are a combination of equity and debt instruments.
Before you start investing, it’s important to consider the risk associated with the scheme and also your own risk appetite, financial goals, current financial situation, and investment horizon. A risk planner can help you assess these factors and recommend the SIPs most suited to you. Moreover, a risk planner can diversify your portfolio and strategically allocate your assets to optimise gains while minimising the risk associated.
Conclusion
As the name suggests, SIP is a systematic and organised way for investors to gradually build their wealth over time through regular contributions. One more advantage of SIPs is their versatility for goal-based financial planning. They are not just a good option for wealth creation, but also for other financial goals such as building a retirement fund, buying a house or a car, building an emergency fund, and funding children’s education. So what are you waiting for? Start your journey of wealth creation today by researching different mutual fund schemes, assessing your financial situation, and consulting with an investment planner. Let your SIP journey begin!
