Systematic Investment Plan (SIP): Meaning, Benefits, How It Works (2024)

Nowadays, SIP is considered one of the best investment options for individual investors. By making small investments regularly, you can accumulate a bigger corpus in the long term, which will help you to fulfill your financial goals. In this blog, we will dive deeper to understand the meaning of SIP, how it works, and its benefits.

What is SIP?

SIP stands for “Systematic Investment Plan”, a method of investing in mutual fund schemes where an investor invests a fixed amount of money at regular intervals (typically monthly or quarterly) rather than making a one-time investment.

SIPs offer a disciplined and convenient way for investors to build wealth gradually, benefit from rupee cost averaging, and harness the potential of compounding over the long term. This approach is well-suited for individuals in India looking to achieve various financial goals, such as wealth creation, retirement planning, or funding education while providing flexibility to adapt to changing financial circ*mstances.

How does SIP Work?

Before you set up your SIP, there are a few essentials you need to know about how SIP works.

There are four stages to investing in SIP from the beginning to the point where your funds are invested in a mutual fund scheme:

Select a mutual fund scheme

As your first step in the SIP investment journey, you need to select a mutual fund scheme you want to invest in. If you need some help with choosing a mutual scheme, take a read through our primer on how to choose a mutual fund.

Select the investment frequency

The next step in your SIP investment journey is to choose an investment frequency you feel comfortable with. The most common choice, especially among salaried investors, is a monthly frequency since they receive their salary monthly. However, if you have reasons to select a different frequency, you may choose to invest weekly, quarterly, semi-annually, or annually.

Set up SIP with a mutual fund scheme

Setting up your SIP is a simple process once you’ve picked a mutual fund. On ET Money, go to your chosen mutual fund, and click on invest. If you’re a first-time investor, complete your KYC and enter the bank details along with your SIP contributions and frequency, and you’re done. The process has been illustrated in detail in a later section.

Automatic debits and unit allotment based on NAV

Once everything is set up, money will be debited from your registered bank account. It will be debited each month based on the date you selected while setting up the SIP. This is an automated process. The funds will keep debiting from your bank account based on the frequency you entered while setting up the SIP.

After the money is debited, you’ll soon receive acknowledgment about your funds being invested. The acknowledgment also includes the number of units you’ve been allotted based on the NAV (net asset value). The number of units allotted for each contribution may differ because the NAV changes every day.

Benefits of SIPs

SIPs offer a broad basket of benefits to investors across age groups and risk profiles. Following are some of the most prominent benefits of SIP plans:

1. Rupee-cost averaging

SIP involves investing a fixed amount at regular intervals, regardless of market conditions. This means that when the markets, and consequently a mutual fund’s NAV, are low, you’re allotted more mutual fund units, on the other hand, you’re allotted fewer units when the markets are at a peak. Over the long term, this reduces your average cost per allotted unit, potentially reducing the impact of market volatility on your investments.

For instance, say you’ve decided to invest ₹5,000 via SIP each month for the next 5 months. Here’s how rupee-cost averaging will work in your favor for this investment:

2. Professional management

SIP investments are managed by experienced fund managers who make investment decisions based on extensive research and analysis. This expertise can potentially lead to better investment outcomes compared to individual stock picking.

3. Financial Discipline

SIP encourages disciplined and regular investing. Investors commit to investing a fixed amount at regular intervals (usually monthly). This helps in building a habit of saving and investing consistently over time.

4. Power of compounding

SIP takes advantage of the power of compounding. The returns generated on your investments are reinvested, and over time, this compounding effect can significantly increase the value of your portfolio.

Power of Starting Early

In investing, the “Power of Starting Early” refers to the belief that if you start investing in an early stage of your life, then you can accumulate more wealth in the long term.

The earlier you start saving, the more time your money has to compound, and even if you start with a small amount, you can add up to large sums over time. This is possible through the power of compounding.

Compounding is the process through which you earn interest on the principal amount as well as on the interest part. This process continues throughout the investment period and generates a snowball effect, which helps you to generate a higher corpus in the future.

Starting early allows time and compounding to work in your favor, allowing you to reach greater financial security and freedom in the future. So, start early, be consistent with your investments, and diversify your investments per your risk tolerance to achieve your financial goals.

Types of SIP

Now that a lot of ground has been covered on what SIP is, how SIP works, and the benefits of SIP, let’s talk about the types of SIPs you can opt for.

1. Fixed SIP

Fixed SIPs are the plain-vanilla version of SIPs. You choose an amount, and a date till which you wish to contribute, and the rest of the process is automated. This has been discussed so far in the previous examples, but you should also know that unless you set an end date yourself, these SIPs will terminate by default in the year 2099. Given that 2099 is in the distant future, it’s not something you should worry about. Though fixed SIPs are also the most popular choice among investors, there are other types that could potentially suit your investment style better.

2. Top-up SIP

Top-up SIPs are great for investors who want to increase their SIP contributions periodically. An example of where top-up SIPs make a lot of sense is when your income continues to increase every year. The investor could choose to contribute the entire increment or a part thereof to the SIP by opting for a top-up SIP. For instance, if you currently invest ₹20,000 a month, and your income increases by 10% each year, you could choose to increase your contribution by the entire incremental income, a part of it, or take a simple approach and just increase your contributions by 10%.

3. Perpetual SIP

Perpetual SIPs are just fixed SIPs sans tenure. Once registered, your bank account will be debited with the amount of the SIP contribution unless you instruct the fund house to stop withdrawals. If you don’t want your investments to be limited to a certain number of years, perpetual SIPs are an ideal option that eliminates the need for repeated renewals. You can redeem your investments anytime you choose, of course.

4. Flexible SIP

It offers you the flexibility to change the amount per contribution or skip a few contributions if you so choose. There are two possible reasons an investor may want to change the contribution amount or skip a contribution. First, your contributions through SIP are adjusted based on the market’s overall outlook. If the market is valued higher, your monthly contributions through SIP would be reduced and increased again once markets are correct and valuations look attractive. Fund houses do this based on a predecided valuation matrix. You will get to decide the minimum and maximum SIP investment amounts. Please note that you must inform the fund house about these changes a week before your SIP installment is due.

Things to Consider While Starting SIP

Before you start your first SIP, there are a few things you should consider the following things:

1. Investment goals

It’s best not to begin investing by calling “growing wealth” your goal. Tie your investments to important milestones of your life that may require a large amount of money — for instance, a bigger home, your child’s college, or your retirement. This will help you keep tabs on your objectives, and performance of how each of your investments is performing, and make it easier to take corrective action when required.

2. Time horizon

Once you have a goal in mind, you know how many years you’d want to achieve it. If you have a long time horizon, you could take on more risk than if you had a short time horizon. If you’re closer to retirement and don’t want to take on many risks, you could stick to short-term mutual fund investments.

3. Risk appetite

Another aspect to consider is how much risk you are willing to take. Assess the risk linked with the mutual fund by examining the volatility of its returns. It’s important to verify that the fund’s risk profile matches your personal risk tolerance. By considering your risk tolerance, you can select SIP options that match your financial goals

4. Mutual fund category

Selecting a mutual fund category requires careful consideration of your time horizon and risk tolerance. For those with a long-term outlook and higher risk tolerance, categories like focused funds or small-cap funds offer the potential for greater returns. Conversely, debt funds are suitable if you lean towards lower risk or have a shorter time horizon. Hybrid funds might be ideal for those seeking a balanced approach.

5. Trial run your strategy

Once you’ve figured all the elements out, try to do a trial run for your investment over your time horizon via an online calculator to see how much you’ll generate as returns and how much your maturity value will be. This will help you understand if your investment strategy will actually help you achieve the goal you’re investing for.

For simulating your returns, you could use an SIP calculator to see how much you’ll generate given a certain amount of monthly contribution made over a certain time and the expected rate of return

Which Are the Best SIP Funds?

The best SIP funds for an investor depend on several factors the investor’s risk profile and the fund’s return consistency, among others. As of this writing, the following are the best SIP mutual funds to invest in:

Final Thoughts

Starting SIP could be one of the most rewarding parts of the investment journey. It gives you ample flexibility and minimizes the time and effort you’d otherwise need to put into managing your investments. If you’re young, now is a good time to start your SIP. Remember, time is on your side; make the most of it.

Frequently Asked Questions