Every investment expert that you come across will tell you that the best way to invest in mutual funds, especially equity mutual funds, is through SIPs. We keep hearing and reading about SIPs a lot, but a lot of investors don’t really understand what SIPs are. Let’s dig deeper into the concept of SIPs and answer a few commonly-asked questions about it.
What is the meaning of SIP?
An SIP is a systematic investment plan. As the name suggests, an SIP is a method to invest systematically in a mutual fund. Basically, when you start an SIP, you give the mutual fund a mandate to deduct a fixed amount periodically from your bank account. For example, if you start a monthly SIP of ₹10,000 in a mutual fund, that amount will automatically be deducted from your bank account and invested in that mutual fund on the pre-decided date. This makes an SIP an automated way to invest.
What are the benefits of SIPs?
The benefits of systematic investment plans can be understood in two ways–monetarily and psychologically. In the first sense, investing through SIPs is more rewarding than lump sum investing over the long-term. An SIP allows you to invest at different levels of the market and benefit from rupee cost averaging. The equity markets go up and down and won’t be at the same level every month. This means that for the same amount of investment, you will be able to buy more mutual fund units if the markets are low and less units if the markets are high. This will average out your cost of acquisition to a good reasonable amount.
The psychological benefit of investing through SIPs is that it will help you build the habit of investing. Since SIP is an automated form of investing, your money will get invested without you having to remember to make that investment. An SIP makes you less likely to shy away or procrastinate an investment.
How to invest in an SIP?
You have to first choose a mutual fund that you want to invest in. Once the choice has been made, you can start a paperless SIP online by using your netbanking account. There is usually no need to sign cheques and fill out forms. The process can be done entirely online on ClearTax.
Is an SIP mutual fund different from a regular mutual fund?
SIP is a way of investing in a mutual fund. The other way is a one-time investment, which is generally called lump sum investment. For either method of investment, the mutual fund remains the same. You can invest in any mutual fund through SIPs or make a lump sum investment.
Do SIPs deliver better returns than lump sum investing?
Not always. When the markets are in a bull run, going from one high to another, a lump sum investment in an equity fund will probably earn better returns than an SIP. But the lure of higher returns can also lead to a major loss if the markets crash after reaching a high. And this happens often. Equity markets are volatile and if you end up catching a market peak after investing a lump sum amount in an equity fund, you will face heavy losses when the markets crash.
SIPs in equity funds help in insulating investments from a crash. The advantage of SIPs is that even in a volatile market, you keep investing and buying at different levels. If the markets are high, you buy fewer units of the fund and if the markets are low, you buy more units for the same amount. This helps you ride out the volatility and earn better returns.
Let’s validate this with an example. Suppose you had ₹2.3 lakh to invest in August 2015. You invested the entire amount in lump sum on 20 August 2015 in a diversified multi-cap fund like HDFC Equity. Then, the markets crashed by over 1,600 points on 24 August 2015, which is something you wouldn’t have known a few days before. So, how would your lump sum investment of ₹2,30,000 have fared? Immediately after a month, your investment would be down by more than -6%. If you had been brave enough to continue holding your investment, it would have grown to around ₹2.7 lakh by 21 June 2017. But most investors would have run away after seeing a major loss. Very few would have stayed invested.
But suppose, instead of investing a lump sum, you decided to start an SIP of ₹10,000 in the same fund. Then, till 21 June 2017, you would have invested ₹2,30,000 and your investments would have grown to over ₹2.8 lakh. A return of more than 20% per annum.
This is the real benefit of investing through SIPs. We never know when the markets will crash and it is best to spread our investments over a period of time instead of taking the risk of catching a peak through a lump sum investment.
Which is the best date for SIP?
There is no specific date that can be said to be the best date for an SIP. However, the beginning of the month would be a good time for SIPs as you would receive your salary at that time and would have enough money to invest.