What Exactly Is A Systemetic Investment Plan (SIP)
Remember the age-old wisdom, “Little drops of water make the mighty ocean, little grains of sand make this vast land?” That is very similar to what a SIP does. You commit a specific amount of funds to be invested each month on a particular date. Based on the market price of the fund (NAV), units are credited to your account. The beauty of the SIP facility is that even a small monthly contribution invested in equities can grow into a large corpus over the long run. But how do SIPs create wealth? You can use a SIP calculator to figure this out, but let us understand why SIPs create wealth.
Firstly, in the long run, time matters more than timing in the market. That is where SIP scores as it is a fixed investment (typically equity funds) without trying to time the market. Secondly, the power of compounding works brilliantly over a more extended period. Generally, after 6-7 years, you earn more by way of return on return than return on principal. That is when compounding picks up momentum. If you do an SIP for 25 years, then from the seventh year to the twenty-fifth year, you will create immense wealth. Thirdly, wealth creation is about discipline and SIP is nothing but a discipline as it forces you to target savings, instead of just investing what is left of your income after spending. Above all, it is the power of rupee cost averaging. When NAV is up, you get more value; when NAV is down, you get more units. Over a longer period of time, you end up much wealthier.
How Much Difference Does Time Make To SIP Wealth?
If you are still wondering what is SIP and the merits of a systematic investment plan; we can get it through this SIP calculator example. Assume that 3 investors do SIPs of different amounts but start at different times and end at the same time. Let us assume Investor Alpha starts investing ₹10,000 per month and does it persistently for 30 years. Investor Beta starts 10 years later, but invests ₹20,000 per month over 20 years. Finally, Investor Theta starts after 20 years, but invests ₹50,000 per month over 10 years. Who is the smartest?
The table below captures the impact on wealth of each of these investors at 14% CAGR.
| Investor | SIP/month | Tenure | CAGR (%) | Investment | Value | Wealth ratio |
| Alpha | ₹10,000 | 30 Years | 14% | ₹36 Lakhs | ₹459.96 Lakhs | 12.78X |
| Beta | ₹20,000 | 20 Years | 14% | ₹48 Lakhs | ₹234.70 Lakhs | 4.89X |
| Theta | ₹50,000 | 10 Years | 14% | ₹60 Lakhs | ₹124.65 Lakhs | 2.08X |
What is the outcome when they all review at the time of retirement. Alpha was the smartest of the lot. He started small and persisted. Till retirement, he had invested the lowest and had created wealth that was 12.78 times his investment. As the tenure of investment persistence reduces, the wealth ratio also reduces. The moral of the story is that in SIP, it is not the timing but time that matters. It is not the size of the SIP but the early start of the SIP that counts.
How So SIPS Compare With Bank FDS?
It is said that comparisons are odious and in this case comparing an equity SIP with a bank FD would be like comparing apples and oranges. However, it would help to put a systematic investment plan in the right perspective. Having understood What SIP is and how time works wonders in SIP. The SIP calculator also tells how much of actual wealth you can create. Let us now turn to the comparison of SIPs with bank FDs. In terms of safety and security, it is the bank FD that would score high. However, let us look at risk, tax efficiency and wealth creation potential.
On risk, the bank FD appears to score. However, there are two finer aspects. In the long run, the biggest risk is not taking on enough risk. Secondly, over the long periods, equity tends to be relatively stable with low probability of earning negative returns. Let us talk about tax efficiency. Interest on bank FDs is taxed at normal rates. However, capital gains on equity fund SIPs are only taxed at 12.5% and you have the additional benefit of ₹1.25 lakh as base exemption in lieu of indexation. On wealth creation potential, there are not two questions that an Equity Fund SIP will score hands down.
Ground Rules For SIPS, To Make Them Most Effective
SIPs are largely on auto mode. However, basic checklist can help things further. Here is the checklist.
- Start SIP early or as soon as you start earning. The amount of SIP is not material, but starting early is what matters. Even small SIPs can grow substantially over the long run.
- Once you start a SIP, be careful not to terminate it in between. It makes a big negative impact on your long-term creation. If there is a cash crunch, you can put the SIP on hold for a few months and start again, but termination of SIP must be avoided.
- Tag SIP to goals, which gives a sense of purpose to the SIP. Otherwise, they will be like random investments. When the SIP is tagged to a goal, it acquires a purpose, and it becomes a lot simpler to monitor the SIP performance vis-à-vis the goals.
- If you are looking at long-term wealth creation, then SIPs on equity funds are the best bet. Equities are volatile, so you make the best of rupee cost averaging. Also, equity returns (even on the index) have been very attractive over the long run.
- Be committed to your SIP, not the mutual fund AMC or the specific fund. If you find that the SIP fund is consistently underperforming the benchmark and the peer group on a rolling returns basis, it is best to think with your feet.
- What is the ideal SIP amount, SIP date and ideal SIP starting age? There are no hard and fast rules, but let your goals decide the amount of SIP. Also, the date can be anything, but just remain consistent each month. Regarding starting age, it should start as soon as you start earning or as early as possible.
- Add to the power of SIPs with stepped-up SIPs. Each year, you can set up with your fund to automatically increase the monthly SIP commitment. This can be increased in terms of rupee amount or percentage. The idea is to let the SIP contribution grow with your level of income.
The SIP Calculator will tell you how much wealth you can create with the help of SIP over a longer tenure. Remember, the Systematic Investment Plan or the SIP is designed to make the best of time without timing the market. If you have understood What is SIP, the next step is to ensure that your actual SIP gets operational.
Disclaimer: Mutual Fund investments are subject to market risks, read all scheme related documents carefully. SBISecurities ARN-0011 | AMFI-Registered Mutual Fund Distributor. Do check the schemes carefully to choose the most suitable one for you.