Why Is SIP The Better Way To Invest In Mutual Funds?

These days, a lot of people are drawn towards mutual funds, especially after realizing how low the interest rates have fallen down over the years. Also, investing in conservative schemes means keeping your money locked in for a longer duration. Mutual funds offer great liquidity. Their returns may be market linked and not guaranteed but in the long run, they can help investors achieve certain financial goals like retirement planning.

Mutual funds can prove to be a wealth creation tool if one decides to invest in a systematic and disciplined manner. There are two ways to invest in mutual funds – either by making a lump-sum investment or through the SIP route. Systematic Investment Plan or SIP is where the retail investor decides on an investment sum that he or she is comfortable investing periodically and then continues this investment journey till the investment objective is accomplished. SIPs have different intervals – weekly, monthly, quarterly, biannually, and yearly.

Although both SIP and lump-sum can help investors in long term wealth creation, what is it that makes SIP a better way to invest in mutual funds? Let us find out.

Understanding how SIP in Mutual Funds work

A Systematic Investment Plan allows the investor to route regular investments in mutual funds. Investors can either make manual SIP investments or can even automate their SIP transactions. If they do so then every month on a fixed date, the predetermined SIP sum is debited from the investor’s savings account and transferred to the mutual fund account. Then, depending on the SIP sum and in quantum with the current NAV, investors are allotted mutual fund units. Many mutual funds allow investors to start a SIP with a sum as low as Rs 500 per month. Investors must refer to the mutual fund Scheme Information Document (SID) to determine the minimum SIP investment sum for that particular scheme.

One must not confuse SIP to be a tool that will protect their investments or help them earn capital appreciation. The performance of one’s mutual fund investment will entirely depend on how the underlying securities in the portfolio perform. A SIP is just a way to invest in mutual funds and not a scheme in itself , as wrongfully perceived by some.

SIP v/s Lump-sum

What makes SIP investments unique?

Novice investors are often left in a dilemma as they do not know when to enter the market. But with SIP, they do not need to time the market and can start their investment journey anytime. If one makes a lumpsum investment, there is always a significant risk involved considering the unpredictable nature of the market. But when you invest via SIP, you only expose a small portion of your investment every month. Your investments are spread across the time horizon and hence, SIP investments do not expose your entire financial portfolio to the dangers of equity markets.

Also, since you invest periodically, SIP allows you to invest across different market cycles. So when the markets are underperforming and the NAV of the mutual fund scheme is low, you can buy more units with the SIP sum. Similarly, when the markets are underperforming, you buy fewer units with the same amount. As equity markets fluctuate from time to time, you might be able to buy more units at a lower NAV in the long run. This averages out your unit cost of purchase and this investment technique is referred to as rupee cost averaging.

Also, long term investing in mutual funds via SIP may allow the investments to witness the compounding effect. With the power of compounding, investors might be able to convert their small SIP sums into a sizeable corpus in the long run.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.