What is Systematic Investment Plan (SIP)? How SIP works?

You would have seen many advertisements on television about SIP or Systematic Investment Plan. Many of the banks and non-banking financial institutes also advertise for SIP and Mutual Funds but do you know what SIP is all about? Well, in this article, we are going to tell you what exactly a Systematic Investment Plan is and we are also going to tell you how it works. So, let us now start with the first section about Systematic Investment Plan.

What is Systematic Investment Plan [SIP]?

Systematic Investment Plan

Systematic Investment Plan is often referred to as a ‘Good EMI’. Now you might question that how an EMI can be good? To answer that, we would first like to tell you that the SIP is related to Mutual Funds. There are two ways to buy mutual funds. One of the ways to make the purchase is in form of Lump sum investment where you can buy the mutual funds as and when you like. The second way of investment is the SIP. In this, an amount is deducted directly from your bank and the mutual funds are purchased automatically with this pre-decided amount.

So, to summarize we can say that SIP is a regular investment in mutual funds and this investment happens at a regular interval. This is more like automating the investments for you.

How do SIP works?

It is quite important to understand how does SIP works. We are not going to complicate this for you and to help you in understanding the working of SIP, we will list the working in a step wise format.

Initiating a SIP

  • Before a SIP starts, you open an account with a financial institution who act as a broker. There are several reliable options available in the market. The account opening process is easy and quick.
  • Once you have an account, you choose the mutual fund that you wish to invest in. Now, you can also seek advice from your relationship manager to ensure that you invest in the mutual fund based on your needs and risk appetite.
  • After selecting the mutual fund, you can go ahead and choose the frequency of the investment. Most of the people select a monthly You can also choose the date when the deduction should happen.
  • Now, you can choose the amount of investments that you would like to make and this amount will be deducted from your bank account on monthly basis on the date that you select. The account details are already seeded with your broker.

Post Deduction

  • Once the amount has been deducted from your account, the amount will be sent to fund house for the purchase of the mutual funds.
  • The funds will then be purchased on basis of the current NAV of the mutual fund. It will soon reflect into your account and you will be able to track your funds that way.
  • You must note that the fund unit can also be allocated in fractions unlike the shares of the company which can only be allocated in whole numbers.

The Winning Strategy

Now you know about the functioning of SIP but do you know why so many people recommend SIP? What is the difference between the SIP and the lump sum investments? Well, you will find the answer here.

  • To begin with, SIP induces discipline in the investments. Now if you make lump sum investment then you might end up missing the investments in a particular month. This can be really problematic but if you setup a SIP then the amount will automatically be deducted and you won’t have to worry about making the investments.
  • You should always select the date of deduction after the date of your salary. For example, if you receive your salary on the last working day of the month then you must select the SIP date within the first 5 days of the next month
  • Another reason why SIP can help you is the fact that it average outs the risk. Now, there is a possibility that the market might be at a high during one purchase and market might be at a low during the second SIP. All this basically cancels out the market risk that an investor faces because of the conditions that are beyond anyone’s control

A lot of people may still question the difference between the Recurring Deposit and SIP. The only difference here is the fact that your money is invested in a secured deposit if you opt for a recurring deposit whereas, your money is invested in mutual funds in SIP. The rate of return for Mutual Funds is usually higher than the rate of return for fixed deposit. Also, the compounding returns usually make the investment very attractive for the investor.

This was all about the standard SIP that is available for an investor. We hope that the article has helped you in increasing your financial knowledge and we hope that you will be able to plan your investments in a better way.