Benefits Of Systematic Investment Plan (SIP)

Karan, a 30-year old, finally decided to invest in Mutual Funds. While discussing where and how to invest with his friends and family, the common thing he heard from them was to invest every month using the SIP route. Not sure about what SIP is and why everyone recommended it, he did some research on SIP benefits. Karan was shocked to know that over Rs. 8,000 crores are invested in Mutual Funds every month through SIPs. But he still couldn’t find the reason behind the popularity of SIPs.

Karan is not alone. Most people thinking about investing come across or are aware of the term SIP. But why should they be starting SIP is something they don’t get a clear answer to. Not anymore.

In this blog, we talk about the key benefits of using SIP to invest in Mutual Funds.

SIP Benefit 1 – No Need To Worry About Market Volatility

Markets mirror the economy, and just like there are ups and downs in the economy, there are ups and downs in the markets as well. While a fall in markets means the returns earned do get erased to some extent, a SIP makes these falls work in your favor.

How does SIP benefit you? Since you are investing every month, your purchase price differs every month, and you get a different number of units. Now, when the markets are going up, the price will be higher every month, and you will get lesser units. However, when the cycle turns and markets start falling, the purchase price falls, and you start getting more units for the same investment amount. This investing at different stages of the market averages out the cost, and that’s why it is called Rupee Cost Averaging.

Let’s understand this SIP benefit with an example.

Say you started a SIP of Rs. 5,000 every month in an equity fund. Assume the mutual fund scheme’s NAV (value of each unit) was Rs. 25 in January. So the number of units you accumulated was 200 (5,000/25).

In February, there was a sharp correction in the market. Due to the correction, the NAV of your fund fell to Rs 20. So the number of units you received in February was 250 (5,000/20). In March, let us assume your fund’s NAV dropped further to Rs. 18. So the number of units you got in this month was 277.78 (5,000/18). In April, the fund’s NAV recovered completely and rose to Rs. 30. The number of units you got was 166.67 (5,000/30).
So the total number of units at the end of April is 894.45 (200+250+277.78+166.67).

The benefit of rupee cost averaging is clear. Since you continue to invest during ups and downs in the market, your average cost per unit at the end of April has come down to Rs. 22.36 at a time when the fund’s NAV is Rs. 30. You benefit from this scenario as your principal invested amount is Rs. 20,000 and the value of your total investment is Rs. 26,833.

So if you are investing in a SIP, you do not need to think about the ups and downs of the market cycle, as the cost automatically gets averaged out.

SIP Benefit 2 – Helps Build Big Corpus with Small Amounts

You must have heard the famous saying, little drops of water make the mighty ocean. It simply means that even with the combination of tiny little things, you can achieve extraordinary things. In the investing world, these small little magical things are Systematic Investment Plans (SIPs).

When you regularly invest in a mutual fund scheme through SIP, your total investment amount grows to a huge corpus in the long run. A major reason for this growth in your corpus is the advantage of compounding.

You benefit from this simple yet powerful factor called compounding because returns from mutual fund schemes get reinvested, and you earn returns on your returns. To better understand the exponential growth of SIPs in the long run, you can make use of the SIP Calculator App. This app provides a comprehensive analysis of your SIP investments, including the projected growth of your corpus based on various factors like investment amount, duration, and expected returns

Let’s understand how SIPs witness exponential growth in the long run with an example. Say you start a monthly SIP of Rs. 10,000, and despite all the ups and downs that come with equity investing, you get a 12% average annual return for the next 30 years. Here is what your investment journey will look like.

As you can see in this graph, during the initial years of investment, your overall returns are growing largely in line with your principal investment amount and the impact of 12% average annual return is hardly noticeable.

The total investment value is increasing primarily due to a cumulative increase in the amount invested. But as you cross the 10th year, something magical happens.

The line of total investment value, which was growing gradually, suddenly started to pick up the pace. By the end of the 30th year, the amount invested by you via SIP stood at Rs. 36 lakh, while the total value of your investment rocketed to Rs. 3.5 crore. In other words, your profit is nearly 9 times your original investment. This magic is compounding. And the trick of this magic can start with a small amount of investment through SIP.

SIP Benefit 3 – Brings Investing Discipline

It is difficult to save money when you spend first and then look to invest the remaining amount. Ironically, the lazy style of investment through SIP inculcates financial discipline in your life. With the help of SIP, you can follow the golden rule of personal finance – save first and spend later. All you need to do is pick your monthly SIP date right after your salary date. And you will end up investing every month before you start spending.

This commitment that a specific amount of money will go each month for investing forces you to control your expenses and invest for your future. But that is not the only benefit of discipline. Another is that it ensures you won’t miss out on investing when the markets are correcting. As we said earlier, investing in falling markets brings down your overall cost and therefore you earn better returns. However, you do need to invest during those times. SIPs ensure this happens.

Tax Benefits

No, Mutual fund SIPs are not tax-free. If you make a profit when you sell your mutual fund units, you’ll need to pay taxes on your earnings. How much tax you need to pay depends on the mutual fund scheme you invested in and how long you held the units before selling them.

However, investments made in an ELSS fund (Equity Linked Saving Scheme) are eligible for tax benefits under Section 80C of the Income Tax Act, 1961. While there is no upper limit to the amount that can be invested, a maximum of Rs. 1.5 lakh is eligible for a tax deduction as per the Income Tax rules and save up to Rs 46,800 a year as tax amount.

Bottom Line

SIP breaks this conventional wisdom that you need a lot of planning and effort to make money. If anything, SIP shows you that you need to stay away from all the complicated ways of investment such as timing the market, and simply keep investing consistently to manage your finances effectively.

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