What is SIP and How Does SIP Investment Work?

What is SIP?

The meaning of SIP is a Systematic Investment Plan, in which a fixed amount is debited from your account and invested in market-linked plans like ULIP funds (Unit Linked Insurance Plans) and mutual fund schemes. The fund units are allocated at the current market price as per your invested amount. Since the best SIP plans are flexible, you can increase the amount or discontinue investing in the plan whenever you wish.

Why Should You Invest in SIP?

Let us learn the importance of SIP investments with the following example of a common man, Ravi. 

Ravi, a 32-year-old accountant, lives in a rented house with her lovely wife and a 4-year-old daughter. His primary financial goals for the next 20 years are to buy a car and a home and get his daughter married. He does invest in bonds, but that is it.

When projected into the future, his savings (yield from bonds) will not be enough to suffice his future expenses, and he will fall short of achieving his goals. This will primarily be due to 2 reasons:

• The bitter fact is that inflation will grow faster than the returns, eventually dwarfing his savings at the end of the investment tenure.

• Had he invested in equity instruments rather than bonds, he could have earned a higher return.

Ravi justifies his investing in bonds as he believes in playing it safe. 

So the question remains: What should he do to achieve substantial growth without getting affected by the turbulence? 

Well, the only way Ravi can achieve his financial goal is by buying a Systematic Investment Plan. And it is a good enough reason for you to get a financial goal: buying a Systematic Investment Plan.

How to Get Started with SIP Investment?

When it comes to SIP, getting prepared is as important as playing the game itself. As we have got an idea about 'what is SIP' and why we should invest in SIP; now let us know about the process to make SIP investment. 

You need to follow 4 easy steps before you start investing in SIP:

• Set your financial goals- Your goals should be specific and attainable.

• Set a timeline- Decide when you need the money; this will be your investment tenure.

• Decide how much you need to invest- With the help of a SIP calculator, figure out the amount you need to invest regularly to accomplish your financial goals.

• Make a choice- Compare the investment options and go for the best SIP plan that meets your needs well.

After following these simple steps, now you are all set to go. The money can be paid by post-dated cheques or through ECS (Electronic Clearing Service), in which you give a standing instruction to your bank account to auto-debit the investment amount from your account every month. The sum you invest monthly in the chosen fund is invested through regular SIPs, which will grow with market performance. You can always log on to the company’s website and track your portfolio.

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How Does SIP Work?

The SIP’s full form is a Systematic Investment Plan, and you can understand its by working through the following points: 

• You choose a SIP plan that suits your financial goals and risk tolerance.

• As per the current NAV, you are allocated the fund units.

• Your money is invested in financial assets like debt, equity, hybrid, and money market instruments as per the fund’s objective. 

• The asset portfolio and how to allocate your money are decided by experienced fund managers.

Now, let us understand the two underlying mechanisms behind the working of SIP.

1. Effect of Compounding

   Unlike simple interest, compounding involves making the interest earned a part of your base capital, and the subsequent interest is calculated based on this newly increased capital. Therefore, compound interest leads to an exponential growth of your money. The effect of compounding increases as the investment tenure increases. The table below illustrates this fact:

   Particulars	SIP Investment Input (Rs)	SIP Investment Tenure	Rate of Interest	Returns (at the end of the tenure) (Rs)	Total Output (Rs)
   Simple Interest	100	5 years	10%	50	150
   Compound Interest	100	5 years	10%	61	161

   As can be seen, there is a 7% rise in the total output when the interest is calculated on a compounding basis. This seemingly small difference in the final output becomes staggering as the investment amount and period of investment increases.  

2. Rupee Cost Averaging

   Consider a scenario – Gaurav decides to invest in a SIP and buys the market units by investing Rs. 1000 per month for 6 months. He will be bagging more units when NAV is low and lesser units when NAV is high. On the other hand, Rashmi makes a one-time investment by buying units for Rs. 6000 at the current NAV. 

   Who do you think is going to end up with a lower cost per unit at the end of the 6 months?

   Month	NAV (Rs)	The monthly investment made in SIP (Rs)	No. of Units	Average Cost Per Unit	One Time Investment made in a plain Mutual Fund (Rs)	No. of Units	Average Cost Per Unit
   1st	15	1000	67	12.42 Rs/Unit	6000	400	15 Rs/Unit
   2nd	12	1000	83		-	-
   3rd	10	1000	100		-	-
   4th	12	1000	83		-	-
   5th	15	1000	67		-	-
   6th	12	1000	83		-	-
   Total		6000	483		-	-

   As can be seen from the table above, Gaurav will be enjoying a gain of Rs. 2.58 per unit over Rashmi. Gaurav played smart by investing consistently for some time. 

   In the long run, he will be less and less affected by the ups and downs of the market, as the period will lead to an averaging of market fluctuations. This effect is called Rupee Cost Averaging and is primarily responsible for making SIP a lucrative investment.

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Benefits of a Systematic Investment Plan (SIP)

The key benefits of investing in a SIP investment plan are as follows:

• Flexible and affordable investment options- You can always start with smaller amounts and increase the sum of your investment as your earnings grow with time.

• Free of entry or exit charges - If you invested in SIP and discovered that it does not work well for you, you can put a brake on making further investments and withdraw every single penny without incurring a penalty.

• Saves you time - By opting for auto-payment, you drive hands-free. You can go to your own business while your money takes care of itself.

• Keeps you stress-free - Unlike stock trading, you are free of the tension of the market ups and downs as your investments eventually grow through rupee cost averaging in the long -term.

• Saves you from overloading your head - You need not have a know-how of the market or the tactics that go into switching between funds. It is all done for you by the fund managers.

Things to Keep in Mind for Maximum SIP Returns

• Start early, and earn more significant returns.

• Stay longer, and enjoy the compounding effect.

• Be patient, the money is sure to grow in the long run.

• Be consistent, and never skip your monthly payment.

In Conclusion

In this article, we have covered topics like what is SIP, why should I invest in SIP, SIP meaning, how to get started and the perks of SIP. Like the hare-tortoise story, the success mantra in SIP is not derived from how fast you run but is based on how long you run. Here the race is won by starting early and staying longer.