A systematic investment plan or SIP (as it is more commonly known) is a way to invest in mutual funds regularly. It is just like a recurring deposit with the post office or bank where you put in a small amount every month. The difference here is that the amount is invested in a mutual fund (indirectly in stocks etc). The minimum amount to be invested can be as small as Rs 500 and the frequency of investment is usually monthly or quarterly. The idea is for you to set apart a sum every month or quarter, and use that to buy units of a particular mutual fund, regardless of its price. People like such a system because it helps them save regularly and build up an investment. SIPs reduces the chance of investing at the wrong time and losing their sleep over a wrong investment decision. However, the true benefit of an SIP is derived by investing at lower levels. Professional or experts manage your funds invested through mutual funds after extensive research on the company, the industry and the economy and then make investments.
Lets say you invested Rs 1000 every month. And lets say the scheme invested in is available at a rate of Rs 20 per unit. Then in month 1, you will be able to obtain 50 units.
Rs 1000/ Rs 20 = 50 units
In month 2 if the unit value goes down to Rs 10 then you will be able to obtain 100 units.
Rs 1000/Rs10 = 100 units
Hence for Rs 2000 invested over 2 months the total value of your investment at the end of 2 months is Rs 1500.
However if you had invested a straight sum of Rs 2000 in month 1 when the rate was Rs 20 per unit – your net value at the end of month 2 will only be Rs 1000/-. Hence an SIP helps you average out your cost and thereby reduce risk resulting in generating superior returns.
Benefits Of Systematic Investment Plan
- Regular saving habit: Perhaps the best benefit of setting up a SIP is that it forces you to set apart some money every month and enforces saving discipline on you.
- Easy, Flexibility and Liquidity: SIP is easy to start, manage and stop. It gives you flexibility to choose a desired scheme or to with draw in parts. And with conditions you have the money for contingency and emergency use.
- Tax planning: Yes, setting up a SIP in a tax planning mutual fund will help you reduce taxes. But to get the tax benefit you need to lock your funds for minimum 3 year time frame.
(But if you invest the same amount at one go in the same mutual fund – you will get the same tax benefit. Tax benefit is not something exclusive to a SIP.)