What is SIP ? How it works

(Last Updated On: September 8, 2017)

The introduction of Systematic Investment Plan (SIP) in the mutual fund is regarded as one the major breakthrough in the sector. It has helped to attract a new class of investors in the sector who were not comfortable to invest a lump sum at a time. SIP in mutual fund first was launched on December 4, 2010, through BSE Star MF platform. Today, it has around 1.52 crore active SIP accounts that have contributed Rs 43,921 crore in FY 17 and Rs 18544 crore in April-July 2017 period into the mutual fund industry.

So, What is SIP and why it so much popular among mutual fund investors?

What is SIP?

Systematic Investment Plan is an investment mechanism offered in open-ended mutual fund schemes, in which small regular investments are made in a particular MF scheme over a long period of time. It helps in beating the volatility in the market and accumulate large amount at maturity with the small investments made over the period. The investment mechanism is similar to Recurring Deposit scheme in which one saves with the bank and in SIP, one invests in the market and return percentage is far better than RD.

Features

  • Investment can be started with minimum of Rs 500 and then increases in a multiple of Rs 500
  • Flexible intervals with Monthly, Quarterly and Half yearly investment
  • Focused method towards investing with ease
  • The real benefit in SIP comes through the power of compounding. Small investments made earlier in low price magnifies at the time of redemption
  • Helps to average out the fluctuations in the market with investments done at different price
  • Delivers attractive return over a Long term investment horizon
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How does it work?

SIP works on a simple formula, Start Early with Regular Investments to create wealth. It is always difficult to time the market correctly to make huge fortunes due to n numbers of factors constantly affecting the market. But with SIP, it reduces the factor of volatility in the investment as it is spread over a long period of time.

The market constantly moves in an up and down direction, and since a SIP invests regularly in the market whatever the market condition is, some investments are locked when prices are low and some at higher prices, it helps to average out the volatility and achieve a lower average cost per unit.

The SIP calculator in bodhik.com is very comprehensive and easy to use. An investor needs to provide three sets of information i.e Expected saving in a year, Duration of the investment and Expected Return (Normally it is suggested to take between 12-15 percent p.a.).
The calculator will compute the data given and will show the expected return of the investment in Graph and Table format with expected maturity value.

How to start a SIP?

To start a SIP on a particular scheme, an investor has to submit following documents with specific details and mandate.

  • Investment form with details of the investor and MF scheme
  • A SIP registration form, in which details like time period of the SIP investment (5y/10y/20y), the amount of the SIP (Rs500/ Rs1000/ Rs5000), SIP trigger date and in which frequency the investment will be made (monthly, quarterly/half-yearly).
  • A filled up ECS/NACH form in which an investor gives the mandate to AMC to receive funds from the bank account for the SIP amount in the specified trigger date.
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How the SIP investment is taxed?

An equity mutual fund with more than one-year investment horizon is exempted from LTCG and debt mutual fund with more than 3 years on investment horizon are taxed at 20 percent with indexation benefit.

Those SIPs which continues until the time one redeems the investment and new units gets added to the investor’s portfolio. For equity mutual fund all those units added in the past one year of the SIP tenure and gains on those added units are taxed under Short term capital gains @ 15 percent and for debt fund, the capital gains arising from the units added in the past 3 years of SIP tenure are taxed @ 10 percent.

Some Misconceptions of SIP Investment

  • It is designed for small investors only: Fact of the matter is, it is suited best for all types of investors from small investors to high net worth investors.
  • You should not start SIP when the market is high: It is not true, one can start investment through SIP during any market condition. SIPs are purposed to stay invested in for a long time in which all market phase will get factored in.
  • Once SIP is started, you cannot stop or change the time-period of investment: It is always suggested to track the performance of investment regularly. One can stop, change or redeem the investment mid-way of the SIP tenure.
  • One can get better returns from timing the market than committing to SIP: The whole process of SIP is for disciplined investing over a long period of time. Timing the market is a very difficult task and depends on many factors. And the probability of success is very low when you are timing the market to gain huge fortunes.
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Conclusion

Investment in mutual funds through SIP is a game changing development for the industry and investors, as it has helped many small investors to become a part of the system who could not afford to invest a lump sum in mutual funds earlier. In SIP,  Patience and a right fund will work wonders for the investor in long term.

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