What is SIP and how it works: The beginner's guide
Top Tax saving options: Should you invest in ELSS, PPF, NPS, insurance? Watch video
(Image Source: Freepik)
Investing in mutual funds is a great way to build wealth over the long term. However, for beginner investors, it can be overwhelming to choose the right funds and invest in a disciplined manner. This is where
Systematic Investment Plans
(SIPs) come in. In simple terms, SIPs allow investors to invest small amounts of money at regular intervals into mutual funds. This not only makes investing more affordable but also helps investors to stay disciplined and achieve their investment goals. In this comprehensive guide, we will explain SIPs in detail, covering topics such as how they work, their benefits, factors to consider when choosing a mutual fund, and how to start investing in a SIP. By the end of this guide, you will have a better understanding of SIPs and how to use them to build wealth over the long term.
What is a SIP?
A
Systematic Investment Plan
(SIP) is an investment tool that allows investors to invest in mutual funds in a systematic and disciplined manner. It is a mode of investing that enables investors to invest a fixed amount of money at regular intervals, such as monthly or quarterly, into a mutual fund of their choice. SIPs are particularly popular among beginner investors because they provide a low-risk and low-cost way to invest in the stock market.
How does a SIP work?
When an investor opts for a SIP, they specify the amount they want to invest and the frequency of their investment. For example, an investor may choose to invest Rs 5,000 per month in a mutual fund via a SIP. The investment amount is then automatically debited from the investor's bank account and invested in the chosen mutual fund. The mutual fund units are allocated to the investor based on the prevailing Net Asset Value (NAV) of the mutual fund on the day of the investment.
Benefits of investing in a SIP
There are several benefits of investing in a SIP, such as:
Disciplined investing: SIPs encourage disciplined investing by automating the investment process. Investors can choose a fixed amount and a regular interval to invest, ensuring that they invest regularly without fail.
Cost-effective: SIPs are a cost-effective investment tool, as they have a lower cost of entry and management fees than other investment options like stocks or direct mutual fund investments.
Diversification: SIPs offer investors access to a diversified portfolio of securities, which helps reduce the risk of loss from investing in individual securities.
Power of compounding: SIPs harness the power of compounding by reinvesting the returns earned on the mutual fund investments. Over time, this can lead to significant growth in the investment portfolio.
Here are a few examples of how SIPs work:
Example 1: Suppose an investor decides to invest Rs 5,000 per month in a mutual fund via a SIP. If the prevailing NAV of the mutual fund on the day of investment is Rs 100, the investor will receive 50 units of the mutual fund. If the NAV increases to Rs 110 the next month, the investor will receive 45.45 units of the mutual fund. The investor's investment value will have increased from Rs 5,000 to Rs 4,995 in the first month, but the number of mutual fund units held will have increased.
Example 2: Suppose an investor invests Rs 1,000 per month in a mutual fund via a SIP for 10 yeaRs If the mutual fund delivers a 12% annual return, the investor will have invested a total of Rs 1,20,000 over the 10-year period. However, the value of their investment portfolio would be around Rs 3,06,000, assuming the returns are compounded annually. This demonstrates the power of compounding over a long investment horizon.
Choosing the right SIP
To choose the right SIP, investors should consider the following factors:
Investment objective: The investment objective of the investor should align with the investment objective of the mutual fund.
Risk appetite: The investor's risk appetite should be taken into account when choosing a mutual fund to invest in.
Fund performance: The past performance of the mutual fund should be analyzed before investing.
Fund manager: The fund manager's track record and experience should be taken into account when selecting a mutual fund.
Expense ratio: The expense ratio of the mutual fund should be considered before investing. A lower expense ratio is generally better, as it means that the fund's costs are lower, and more of the investment returns will be passed on to the investor.
Investment horizon: The investor's investment horizon should be taken into account when choosing a mutual fund. If the investment horizon is short, a debt fund may be a better option, while a long-term investment horizon may be better suited to equity funds.
Asset allocation: The investor's asset allocation should be taken into account when selecting a mutual fund. If the investor already has exposure to a particular asset class, they may want to consider investing in a mutual fund that provides exposure to a different asset class.
How to start investing in a SIP
Investors can start investing in a SIP by following these steps:
Identify investment goals: The investor should identify their investment goals and determine how much they want to invest and for how long.
Choose a mutual fund: The investor should choose a mutual fund that aligns with their investment goals, risk appetite, and investment horizon.
Open a demat account: If the investor does not already have a demat account, they will need to open one with a registered broker.
KYC documentation: The investor will need to complete KYC documentation and submit it to the mutual fund company or broker.
Set up the SIP: The investor should set up the SIP by providing the investment amount and frequency.
Monitor the investment: The investor should regularly monitor the investment portfolio to ensure that it is aligned with their investment goals and risk appetite.
Conclusion
In conclusion, SIPs are an excellent investment tool for beginner investors who want to invest in mutual funds in a systematic and disciplined manner. They offer several benefits, such as disciplined investing, cost-effectiveness, diversification, and the power of compounding. Investors should consider several factors before choosing a mutual fund, such as investment objective, risk appetite, fund performance, expense ratio, investment horizon, asset allocation, and the fund manager's track record. By following these steps, investors can start investing in a SIP and build wealth over the long term.
(The content is generated with the assistance of Artificial Intelligence)
Start a Conversation
FOLLOW US ON SOCIAL MEDIA
Facebook
Friday, May 5, 2023 at 5:28 am