What is a Systematic Investment Plan (SIP)? How To Calculate, Invest, And Its Benefits?

A systematic investment plan is a process of investing by making regular equal investments in a mutual fund, fixed deposit, or stocks. Systematic investment plans (SIPs) are more popular with mutual funds. The frequency of equal investments in a SIP can either be weekly, monthly, or quarterly.

One can choose to invest as little as Rs.500 via the SIP route. There is no real upper limit for a SIP. Many platforms set the upper limit by default to Rs.25000. However, it is possible to make SIP investments of Rs.1 lakh or even Rs.5 lakh. It all depends on the financial goals of the investor.

SIP investing is different from a one-time lump sum investment. A one-time investment is very time-sensitive, and a market crash can cause major losses. A SIP, on the other hand, protects the investor from market crashes. In fact, market crashes are good with SIP investors because they get to buy more units of lower NAVs with the same amount of investment money.

With a systematic investment plan, the investor does not need to have all the money intended to be invested at once. The investor can gradually invest, week by week or month by month, and create a large corpus or fund over time. The only thing an investor has to make sure is a regular flow of money from which a certain portion can be saved and invested towards the SIP.

Furthermore, SIPs in ELSS mutual funds have a tax benefit in terms of the exemption for up to Rs.1.5 lakh per annum under section 80C.

How does a Systematic Investment Plan work?

A SIP involves the regular purchase of mutual fund units at the prevailing market price. By purchasing units of a mutual fund (or the asset class in which you have started the SIP) at regular intervals, your investment account grows in value over time.

The number of units purchased depends upon the price or NAV. If the equity markets are doing well, the NAVs may be higher. That would mean a lesser number of units purchased because the amount of money available every month (or week) to purchase the units is fixed.

Similarly, if the NAV is low, then a higher number of units are purchased because the same amount of investment can now afford a larger number of units.

A SIP works best over a long period of time. Therefore, investors should not expect a quick return from a SIP investment. SIPs are designed to meet long term financial goals towards which an investor will work gradually, month by month.

Benefits Of Systematic Investment Plan
Benefits Of Systematic Investment Plan

Benefits of Systematic Investment Plan

1. Financial Discipline

There are plenty of benefits of investing via the SIP route. Firstly, the structure of a SIP adds financial discipline to an investor’s life. Signing up to a SIP creates an obligation for the investor to set aside a fixed sum of money every month for purchasing units of a mutual fund.

Discipline is the number one requirement for achieving financial goals. You will be surprised to know how many people fail to achieve their financial goals due to a lack of discipline. Many people start investing well, but lose interest or simply stop making investments for their future a few months down the line.

By signing up for a Systematic Investment Plan, you are attaching yourself to a long-term commitment to stay on track with your investment goals.

2. Rupee Cost Averaging

The second big benefit of investing via the SIP route is the concept of rupee cost averaging. Equity markets, in which equity mutual funds invest, tend to be quite volatile. Hence, prices of stocks move up and down constantly.

Hence, if an investor were to make a one-time lump-sum investment, then the timing has to be spot on. Buying at a peak will result in lower returns and buying at a trough or a low will mean higher returns.

However, not every layperson has the skill and the knowledge to determine when exactly the market has hit a peak or when the market is in a trough.

So, the alternative is to invest regularly over a period of time and average out the highs and the lows. A SIP allows the investor to buy mutual fund units at different prices over time.

At high market prices, the investor’s account sees lesser units added while at low market prices, a greater number of units get added. Over the long term, the high-priced units and the low-priced units get averaged out.  Rupee cost averaging takes out market timing from the investment equation.

3. Low Financial Burden

Since SIP allows for very small amounts to be invested periodically (as low as R.500), the financial burden for the investor is also not very high. One does not have to wait until one accumulates a large amount of money for investment. In a nutshell, investments can happen in baby steps too.

SIP also breaks a popular misconception that only rich people make investments. The fact is that financially smart people make investments. I say this, that one does not have to be rich to make smart decisions. Absolutely anyone with even a monthly saving of Rs.500 can invest via SIP.

The low minimum requirement of SIP amounts provides a strong incentive for an investor to keep investing and consequently, stay invested for a long period of time.

4. Power of Compounding

The term “power of compounding” is probably one of the most overused terms in the investment world. But that does not take away any of the benefits of compounding. SIP also allows the investor the opportunity to benefit from compounding.

Every one of the investor’s monthly SIP investments will grow as the portfolio of the mutual fund grows. For example, if Rs.1000 is being invested every month for 5 years, then by the end of that period, all of the installments will compound at the rate with which the mutual fund grows. It can be derived that the earliest instalments will see the most compounding which the most recent ones will see the least compounding.

Lump-sum investments would theoretically see a better compounding than SIP investments. The reason is that the entire lump sum amount appreciates at the mutual fund’s growth rate. In SIP, different installments will appreciate with different rates since their duration of compounding varies. But lump sum investments will work out to be better only if the timing of the investment is right. 

5. Convenience and Flexibility

SIP investing is quite flexible when it comes to stopping the plan. If your situation does not allow you to make further monthly investments, or if you want to move into another investment, then it is not very difficult to stop the SIP.

You simply have to give instructions to the AMC or the broker with whom who have done your SIP. Furthermore, you might be able to stop the SIP from the comfort of your home by using the online option.

The duration of SIP can also be easily changed. If you wish to shorten the duration, then you simply have to inform the AMC for the company managing the fund in which you have invested. You can also lengthen the duration of your SIP when your SIP ends. At that time, you will be given the option of renewing your SIP for a duration that you desire. 

Investing in mutual funds or equity markets via the SIP route is also very convenient. You do not have to perform research on where you have to invest. Simply invest in the fund which you have selected.

You also do not have to go to the bank or make any money transfer every month. Once the SIP standing instruction is given, the system takes over and the money gets deducted automatically from your bank account every month.

One can be a passive investor and still enjoy returns from the equity and debt markets via the SIP route.

SIP Calculator

How to Invest in SIP?

Step 1 – Prepare a plan

The very first thing that you need to do before you invest in SIP is to make a financial goal. What is the reason for you wanting to do a SIP? Is it to have enough money for retirement? Is the intention to pay for your child’s education? The list could be quite varied depending on person to person.

You basically need to know two things: how much money you need and by which year (in the future) you need that money. Then, based on a conservative growth rate, you need to figure out how much SIP needs to be done every month in order to reach your target.

If your monthly investment requirement is too high, do not get disheartened. But make a financial plan. How to achieve the plan is the next step. But simply doing investments without a plan is like driving without a destination. You simply don’t know where you are going.

Step 2 – Choose your funds

The next step is to choose a mutual fund or a group of mutual funds in which you will do a long-term SIP. The best option for a layperson would be to consult a financial advisor and get a list of recommended funds from a trusted and qualified person.

If you cannot go to a financial advisor for whatever reason, then do the research yourself and pick out a couple of funds. Go for a hybrid fund which has a mix of debt and equity. If you are comfortable with risk and wish to go aggressive, then a pure equity option can work. Whatever you select, you must do so carefully because you will be committed for many years to come.

Step 3 – Signing up

After you have prepared your financial plan and have selected the fund in which you want to do SIP investments, the next step is to sign up. You can open an account either with a broker or you can directly approach the AMC.

The first step in opening an investment account is to first do a KYC. This KYC is done by the AMC or the mutual fund company. There are agencies like Karvy and CAMS KRA as well which act as transfer agents and will process your KYC application.

The best thing would be to do your KYC with the fund house whose fund you have selected for your SIP. The transfer agents normally come into play when you go through a broker who has a relationship with one of the transfer agents. KYC applications have no fees associated with the process.

Step 4. – Open a Demat Account

Secondly, you need to open a Demat account with your broker or open an account directly with the mutual fund company (AMC). A Demat account is not necessary if you invest directly with an AMC. The Demat account (or direct account in case of AMC) will be linked to your bank account for easy money transfer.

To invest in a Systematic Investment Plan, you have to give standing instructions to the bank for debiting the investment amount every month (or week/quarter depending on your preference). Consequently, on a fixed date each month, the SIP investment amount for that period will get debited to purchase units of the mutual fund at the prevailing NAV or market price.

A recurring payment facility can be set up using ECS or Electronic Clearing Services. Your broker or the AMC should be able to assist you in filling out the necessary forms for ECS.

Additionally, you also have to fill out a POA (Power of Attorney) form authorizing your brokerage/AMC to purchase mutual fund units on your behalf. There are rules established by SEBI, which require the investor to authorize transactions in the equity markets.

You obviously do not want to spend time authorizing your SIP investments every month. It will be really inconvenient to do so. Hence, you provide a limited power of attorney to your broker/AMC for executing transactions on your behalf.

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Stockquantum was founded by Dharmendra Mukati in 2018. I am a Trader and Investor in the last 10 years. I am writing here about stock broker review, broker comparison, IPO investment, Crypto currencies, technical analysis, fundamental analysis, sub brokership, mutual fund, personal finance, and our experiences.