What is SIP and How SIP works : Working of Systematic Investment Plan
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Let's have a look at: What is SIP or Systematic Investment Plan?
A systematic investment plan (SIP) is a small and easy plan offered to interested mutual fund investors. SIP scheme is very much similar to recurring deposit scheme wherein an investor invests small amount of money on regular basis. The underlying instrument in SIP is mutual fund though unlike RD.
The SIP scheme helps an individual investor to invest in the Mutual Fund schemes in instalments instead of a lump sum of amount.
Examples of few popular investment schemes:
How SIP works?
Step 1: Open an SIP
Many popular fund houses and mutual fund distributors provide SIP scheme plan for attracting interested investors.
Note: Experts believe that its always better to start with systematic investment plan wherein one can increase the amount of investment over the period of time.
For Opening SIP account, the below details to be submitted:
One must provide KYC (Know Your Customer) details viz., copy of identity proof, copy of address proof and a photograph
Step 2: Planning Investment
Once the SIP account is up and running, the investor must decide and plan for:
- Amount to be invested
- Period for which the amount to be invested
SIP is a flexible investment method which encourages an individual to save and build a financial back-up for future.
SIP Investment technique:
An investor will receive number of units of mutual funds based on the amount invested by the investor and mutual fund NAV at that given period of time.
The investor opting for this plan must have a close watch on ongoing market condition to ensure to make proper investment.
Every time you invest money into SIP scheme, additional units of the scheme are purchased at the market rate and added to your account.
SIP returns mechanism:
The investors benefit under SIP scheme from:
- Rupee-Cost Averaging
- The Power of Compounding.
Below we will discuss and understand the above two mentioned concepts to understand how SIP works and earns return.
1. Rupee–Cost Averaging:
Markets are very volatile and are changing every time which makes it very confusing for all the investors to decide when is the right time to make an investment.
Rupee-cost averaging simply means spreading the cost and rupee value over a period of time instead of one point. The rupee-cost average method allows an investor to spread the market glitches over the period of investment and avoid one time market shock.
Under SIP scheme an investor makes regular investment which enables the investor to receive more units when the price is low and lower number of units when the price is high.
Thus, the investor gets the best balanced portfolio and the market ups and down risk is mitigated and impacts are minimised.
2. The Power of compounding:
Compound interest merely means interest on interest.
Under SIP scheme, the investor keeps investing additional money, also the investor earns interest on amount invested and then the investor earns interest on the complete amount (amount invested + Interest earned on investment) which increases his returns.
Thus by power of compounding an investor earns more and hence the earning power is accelerated for the investor.
Withdrawal from SIP
There are no lock-in periods for major of the SIP scheme (except if someone opts for Income TAX saving SIP scheme viz., ELSS). The investor based on his target or requirement can stop investing under the SIP scheme or withdraw all accumulated value under the scheme. This provides SIP advanced liquidity feature.
The highly liquid and flexible SIP which provides an attractive opportunity for many interested investors.
SIP or Systematic Investment Plan: A Final Take
SIP system completely works on rupee-cost averaging policy which helps to mitigate losses and minimise the risk of market exposure. We can't say risk can be eliminated with this method, it can just be reduced to some extent.
The returns are based on power of compounding with effective rate of return.
SIP is also very liquid investment scheme wherein the investor can withdraw anytime the investor wishes.
Also, the SIP account can easily be opened and closed.
This makes SIP system of investment a balanced approach to planned saving. This may seem to be a feasible option for ones who wish to contribute small but regular amount towards their investment planning. But, remember that mutual funds are subject to market risks and you have to be cautious while putting your hard earned money.