A Systematic Investment Plan or SIP is an easy, convenient and smart mode of investing in mutual funds. By virtue of an SIP, you can invest a predetermined amount of money at regular intervals like weekly, monthly or quarterly; in a systematic manner. In other words, it is a planned approach towards creating a healthy corpus over a period of time.
Benefits of SIP
Investing through SIP in a mutual fund offers a diverse set of benefits which are as under –
- Power of Compounding – Albert Einstein has called compound interest, the ‘eighth wonder of the world’. Compounding is a potent force to make your money grow exponentially. The role of time in the power of compounding cannot be ignored. The process is simple – the sooner you invest, the more is the time available for your money to grow.
- Rupee cost averaging – Since a volatile market scenario is a part and parcel of equity mutual funds, there is no point timing the markets. The best way is to opt for an SIP based style of investment, so that you do not have to indulge in a guessing game. Since you regularly and systematically invest in an SIP, your money buys you more units when the price is low and less units when the price is high. Thus, you can see when there is a period of volatility, you can benefit by getting many units at a lowered average cost.
- Flexibility – One of the reasons many of us shy away from investing is because we do not have substantial money to invest and have other monetary obligations, SIP gives you the flexibility to invest in smaller, manageable amounts. There is no compulsion to invest, you can decrease or increase the amount of investment and you can also discontinue, when you want to. There is no investment approach that gives you so much flexibility as an SIP.
- Disciplined approach towards savings – Discipline is a vital ingredient for everything in life, and that includes wealth creation too. When you invest in an SIP, you are setting aside money regularly that grows and compounds to generate a health corpus. So every investment is one step ahead towards reaching your financial goal.
- Convenience – It is a hassle-free way to invest money. You can offer standing instructions to your bank and they can have the money auto-debited from your account. Even redemption is easy these days, as the money comes directly to your bank account.
- Long term wealth creation – The twin advantage of compounding power and rupee-cost averaging helps in delivering high returns over a long-term period. It is advisable to stay invested at least for five years in equity markets to benefit from a substantial corpus.
How does SIP work?
As we mentioned, every month a fixed sum of money is auto-debited from your bank account and invested into a particular mutual fund scheme. A certain number of units is allocated to you, based on the ongoing market rate; this is known as NAV (Net Asset Value) for that particular day.
So, every time you invest money, additional units of that particular mutual fund scheme are bought at that particular rate (NAV) and added to your account. These units are purchased at different rates depending on the market scenario, which explains the rupee-cost averaging benefit of mutual funds.
How much SIP amount should I invest?
The amount you invest, depends on various financial goals you have – children’s education, travel, retirement planning, etc. For instance, if you have a retirement goal of Rs. 1 crore, you have to factor in the inflation rate and decide how much you should invest every month to meet that goal.
How much time I should put in for my investment to take shape?
One is living in a fool’s paradise if one expects to reach Rs.1 crore goal in two years, through equity mutual funds. Especially, if you are investing modest amounts regularly to reach that goal. The power of compounding, as mentioned before, needs time for your investments to grow exponentially. So be realistic with your time horizons. In any case, you need to stay invested for a long term in equity mutual funds, at least five years; to make substantial returns. So, if you have a time frame of 5 years or more, go for equity mutual funds; if it is lesser (average of 3 years or less), invest in debt funds.
Factor in the Inflation
The prices do not remain the same; inflation is a necessary part of growth in any economy. In ten years, a movie ticket may cost five times more than what it is presently. This is why we need to be realistic about inflation, when we plan our financial goals. Here’s one way calculate ‘future value’ of your investments. Let’s say you are investing for your child’s higher education
Open Excel and click on ‘fx’ in the sheet. For ‘Rate’, key in 8 percent (let’s take the inflation rate as 8 percent). For ‘Nper’ (number of years), let’s give it 10 years. Let’s keep the Pv (present value of your goal) as Rs. 10 lakh. Do not fill ‘Pmt and ‘Type’ fields. You will see the future value of your investment (in this case, your child’s higher education) is Rs. 21, 58, 925. This means, you will need Rs. 21 lakh, ten years from now, to fund your child’s higher education, at an inflation rate of 8 percent.
Calculating SIP Investment
Take a historical average; 12 to 15 percent while assuming future rate of return. Hit the ‘fx’ button in your Excel sheet and choose the ‘PMT’ formula. Fill in the following fields
Rate– This is the rate of expected return. Put in 0.01, (We are assuming rate of return at 12 percent. Since we are investing through a monthly SIP, we divide 12 percent by 12 months which comes to 0.01 percent)
Nper– This is the time period for your investment. Put in 120 months (Since you are making monthly investments, 10 year x 12 months =120)
Pv – Keep this blank as you are not investing any lump sum.
FV – For future value, put in the inflation-adjusted goal of Rs. 21, 58,925
Type – Enter 1. If you are making an SIP payment at the beginning of the period, you have to type in 1.
The resultant figure is Rs. 9292.13. This is the monthly SIP you need to pay, if you want to create a corpus of Rs. 21.5 lakh at the end of 10 years, assuming the investment grows at a rate of 12 percent per year.
Apart from Excel, you can calculate both the future value and SIP investments through plenty of online calculators that are available.