Systematic Investment Plan (SIP) A Comprehensive Guide to Follow

Introduction

Did you know the latest sensation of financial markets? It is the humble systematic investment plan (SIP). Inflows into mutual fund SIPs have witnessed a steady increase in the past 12 months – they have risen from ₹18,838 crores in January 2024 to ₹21,262 crores in June 2024, an increase of 12.8% in six months.

The growth is even more eye-opening when compared to corresponding data from a year ago. Inflows through SIP investment plans have increased 44% from ₹14,734 crores in June 2023 to ₹21,262 crores in June 2024 . The numbers point towards the growing popularity of SIP investments and their role in wealth creation for various life goals.

SIPs, through which you can invest a small amount of money at regular intervals in your chosen mutual fund, not only help you build a corpus for life but also bring discipline into your investments. Not only this, it also helps you benefit from rupee cost averaging during market downturns.

Investing a small amount via SIPs regularly is also easily achievable and helps save without any day-to-day intervention. This comprehensive SIP investment guide will help you understand the various aspects of SIP investments for informed decision-making.

What is an SIP?

SIP is an acronym for systematic investment plan. It is a mode of investment in financial instruments like mutual funds. Through SIPs, you can invest any amount of money, starting from as little as ₹500, in your chosen mutual fund at a particular interval.

This could be weekly, fortnightly, monthly, or quarterly. Think of it as a recurring bank deposit. A recurring deposit is a savings plan that involves making regular deposits over a period of time. Offered by banks and post offices, a recurring deposit involves a particular amount of money being deducted from your primary account on a particular date and deposited into the recurring account.

SIP investment plans are the same. The difference is that in SIPs, the money is deducted per the given mandate and invested in a mutual fund. While a recurring deposit offers a fixed rate of return, SIPs in mutual funds don’t have fixed returns.

The small upfront amount required to kickstart your SIP investments means you don’t need a large investible surplus to get started. This makes SIP investment the go-to investment mode for everybody who wishes to invest - young earners, students, housewives and almost anyone.

Factor in your goals and risk tolerance to choose the best SIPs to invest in. Equally essential is to consider the fund’s long-term returns and, specifically, its performance during market downturns before zeroing in on a fund to kickstart your SIP investment plans.

How Does SIP Work?

SIPs work quite simply. Here’s an example to understand how it works. Let’s say you want to invest ₹1000 per month through an SIP. All you need to do is:

• Complete KYC

If you are investing for the first time, you need to complete KYC or know your customer. It is mandatory under the Prevention of Money Laundering Act, 2002. Provide basic documents related to your address and identity to complete KYC. You can complete E-KYC in a few clicks.

• Establish your account

The next step is to establish your account on any fintech platform or directly through the fund house's website. You can register an account, provide your name, email, and phone number, and set up an account to start an SIP.

• Select and configure your SIP

Choose your fund to configure your SIP. Choose the SIP amount (₹1000 in this case), frequency (monthly) and the starting date.

• Connect your bank account

Next, connect your bank account to establish automatic payments on your chosen date. Automatic payments through SIPs allow hassle-free investment. You need not worry about remembering and making payments manually. All you need to ensure is that the required funds are in your account on the SIP date.

• Review and validate

Finally, review and validate your details including SIP amount, frequency and bank account details. Confirm your SIP investment plan to get started. Once your SIP is set up, the amount gets debited from your bank account and gets invested on the chosen date.

You can find recommendations on the best SIP plans on fintech platforms and websites. While you can review them, remember that the best SIP plans align with your goals and risk tolerance. Evaluate your goals and factor in your risk tolerance before investing.

The flowchart below helps you understand the SIP investment cycle:

Types of SIPs

The table captures the various types of SIP plans and their suitability for various investors:

Benefits of starting an SIP

The benefits of an SIP investment plan are multi-fold. Some of them are as follows:

• Disciplined investing

Want to invest but keep pushing for one reason or another? SIPs help you imbibe disciplined savings habits over time. As your money gets automatically invested, it results in a kind of forced savings and investment, which is highly needed to build a corpus for different long and short-term goals.

• Benefit from rupee cost averaging

SIPs help you benefit from rupee cost averaging where you buy more units when markets are down and vice versa. This helps you ride market volatility and average cost in the long run. Let’s understand it with an example. Suppose you invest ₹1000 in a mutual fund whose NAV is 100. You get 10 units of the fund (1000 / 100).

Due to market volatility, NAV falls to 50. During such a scenario, you get 20 units of the fund (1000 / 50). In the long run, this can potentially lower the average cost per unit of the investment.

• Brings power of compounding into play

Compounding is the act of adding interest on interest. To put it otherwise, in compounding the SIP returns earned on your initial investment are reinvested. Over time, this can balloon your corpus.

• Flexibility on offer

SIP investments allow you to adjust your contributions to changing financial situations. For example, while you may start with a small amount when you start earning, upon marriage and having kids, you can increase the amount through top-ups. Similarly, if you face any financial crunch, you can decrease your SIPs or pause them for a few months.

• Helps achieve long-term goals

SIP investments can help you plan and achieve long-term goals like retirement and making a down payment for a house or children’s higher education. For example, if you wish to accumulate ₹1 crore for your retirement in the next 30 years, a monthly SIP of ₹4423 in a fund offering 10% annualised returns can help you build the desired corpus .

Power of investing early

Time plays a vital role in SIP investment returns. It pays to be an early bird, and the earlier you start, the better it is. An early start can help you further leverage the power of compounding to your advantage. In other words, the earlier you start, the greater the time you give your money to grow. Let’s understand it with an example.

Suppose you are 25 and wish to invest ₹5000 per month through SIPs in a mutual fund offering 10% annualised returns till 60. The table shows how much you can potentially accumulate if you start at 25 and also the effect of a delayed start.

As you can see, the final corpus decreases as you lower the investment duration. When you start at 25 and keep investing for 35 years (until you turn 60), the end corpus is ₹ 1.9 crores. A delay of five years brings it down to ₹ 1.13 crores, and a delay of 10 years lowers it to ₹ 66.89 lakhs. Therefore, it pays to start investing early to allow compounding to weave its magic.

Things to Consider While Starting a SIP

Just like starting any good thing requires specific considerations, you need to keep a few things in mind while beginning SIP investments. These include:

• Financial goals

Know the goal for which you are investing via SIPs. Are you planning to build funds for an emergency, buy a house or save for retirement? It’s crucial to align your SIP investments to your goals to:

➔ Remain focussed and committed
➔ Choose the right funds for investment (Debt funds for short-term goals and equity funds for long-term goals)
➔ Track the progress of your SIP investments and make the necessary changes

• Investment timeframe

Consider the investment timeframe for your SIPs. For short-term goals, the investment timeframe can range from a few months to a few years. On the other hand, for long-term goals, you need to remain invested for a long period.

• Risk tolerance

This is another vital consideration before starting SIPs. Risk tolerance reflects your ability to stomach risks. While some individuals have a high-risk tolerance, others have a moderate or low-risk appetite. If you have a high-risk appetite, you can opt for SIPs in equity funds, as they tend to be more volatile.

On the other hand, if your risk tolerance is low, you can choose debt SIPs, as debt funds tend to be relatively less volatile than equity funds.

• Investment amount

SIP investments allow you to start small, from as little as ₹500 per month. That said, you should choose an amount you can invest consistently. This is because only when you invest consistently can you take advantage of SIPs and compounding. You can allocate a high investment amount if you have a regular income. On the other hand, you can reduce the amount if your income isn’t consistent and is irregular.

SIP vs Lump Sum

While there are multiple SIP benefits, there’s another investment approach - lump sum. Unlike SIPs, where you invest a small amount at regular intervals, a lump sum investment entails investing a large amount in one go. Both investments have their pros and cons. The table will help you understand them better.

Pros and Cons of an SIP

Since you know how a SIP works, like anything, they have their pros and cons. The pros of SIP investments include:

• Disciplined investing: SIPs help imbibe a disciplined savings and investing habit by encouraging regular investments. Investment discipline is needed if you wish to build a corpus for different short and long-term goals.

• Low initial investment: You don’t need much to start SIP investments. If you are over 18, you can start a SIP with your pocket money.

• Different types of SIP plans: SIPs offer you a range of choices. You can choose from a plan as per your needs and financial situation.

• Compounding benefits: SIPs help you leverage the power of compounding in the long run. Compounding has a multiplier effect and can boost your corpus significantly in the long run.

• Hassle-free investment: SIPs are automated and thus hassle-free. They are a kind of forced savings that helps you embark on a path to financial freedom.

• Helps ride market volatility: SIPs help you ride market volatility and remain invested across market cycles. By offering the benefits of rupee cost averaging, they help reduce volatility in the long run.

However, SIPs have some cons too. These include:

• No lumpsum gains in a bull market: In a bull market, lump sum investments can offer potentially higher returns. As SIPs are spread over time, you can miss out on higher gains.

• Need long-term commitment: The real beauty of SIPs is when you remain invested for a long-time. If you have a short-term investment outlook, SIPs may not give you the returns you want.

• Returns may suffer if the fund performs poorly: Remember, SIPs don’t generate returns. The funds in which you invest via SIPs do. If the fund performs poorly, your SIP returns may suffer. Such losses are more magnified when markets tumble.

Final Thoughts

SIPs, with their flexibility, convenience and hassle-free investment, can be the start you need to build funds for various life goals. They imbibe a disciplined savings habit and are for all. The rising inflows through SIPs are a testament to their growing popularity. While the benefits of SIP investments are plenty, it’s equally vital to remember that SIPs are no magic wand.

Before starting SIP investment plans in instruments like mutual funds, you need to carefully evaluate your goals, risk tolerance, factor in long-term performance of the fund and ensure the fund’s objectives and risk aligns with you. Also, evaluate the track record and experience of the fund manager along with the fund’s expense ratio. A higher expense ratio can eat your returns.

It’s equally vital to not panic, make impulsive decisions following short-term volatility, and stop your SIPs. In fact, SIPs are more suited when markets are down because they help you buy more units. Redeeming your SIPs during market downturns converts notional losses into actual ones. Investing via SIP investment plans is akin to test cricket, where you require discipline, patience, and commitment in the long haul. Once you do so, you can benefit from SIPs.

Whether you are new to markets or a seasoned investor, it’s never too late to start investing via SIPs. Irrespective of whether you want to accumulate funds for your dream vacation, build an emergency corpus, save tax, or save for your child’s higher education or retirement, SIPs can help you in your endeavour.

Start your SIP journey today and use this SIP calculator to calculate the future value of your SIP investments. Happy investing!

Disclaimer: This article is for informational purposes only and does not constitute financial advice. It is not produced by the desk of the Kotak Securities Research Team, nor is it a report published by the Kotak Securities Research Team. The information presented is compiled from several secondary sources available on the internet and may change over time. Investors should conduct their research and consult with financial professionals before making any investment decisions. Read the full disclaimer here.

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