What is SIP and How Does it Work?

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  • October 8, 2021
What is SIP and How Does it Work?

Systematic Investment Plans or SIPs are investment tools that are usually associated with mutual funds. In an SIP, the investor makes periodic and regular purchases of that mutual fund’s unit rather than making a one-time payment or purchase. Many investors vouch for SIPs and how they are better than making lump sum investments. 

Let us try and understand how SIP works with examples. 

Say you have INR 20,000 in your savings account, not reaping you any benefits. Now, you have decided to invest that amount in mutual funds. 

You can make a one-time lump sum payment of INR 20,000 in a mutual fund scheme and get the required number of units for that amount. 

However, when you make a single purchase, you do not have the advantage of compounding. We’ll discuss it in detail in a bit. You also do not get the liquidity that emergencies might require. Do keep in mind that most equity mutual funds have a lock-in period of 3-5 years. 

Instead, you can divide your amount into small brackets of INR 5,000 or INR 2,000. You can invest this amount every month into the same scheme. 

Let us see what the benefits of doing so are.

Benefits of SIP

  • Makes you a disciplined investor: This is where most people struggle: regularity! When you can’t see immediate returns your investment can get weak in terms of involvement. You may even withdraw entirely. However, with an SIP in place, you become a regular investor, and you do so conveniently. 
  • Ease: You don’t have to move a muscle to continue your mutual fund investments once you have signed up for a systematic investment plan. Based on the NAV at the time of your SIP every month, you will be allotted units. Plus, the amount will be paid from your account automatically. No more hands-on work!
  • Start as low as INR 500: Various mutual fund/asset management houses in India offer products with an SIP option with a minimal investment of INR 500. 
  • Benefit from the power of compounding: When you make regular investments, you also get compound interest. 
  • Rupee-cost averaging: How SIP investment works is that it makes you invest regularly and while you are at it, you are buying units for a mutual fund at different prices. Just by being regular, you rope in units cheaper when the stock market falls. This way, eventually, your investment premium is much lower. 

Now that we have understood how an SIP works with examples, let us look into the different kinds of SIPs to choose from.

Different kinds of SIPs

  • Flexible SIP: Also known as Flexi SIPs or Flex SIP, these use a pre-derived formula that lets you change the amount you have to pay every month based on the market conditions.
  • Perpetual SIP: These SIPs do not have an end date, and unless you have filled an end date in your SIP, it will be considered perpetual and would go on until 2099, although you can always pause and stop an SIP by filling a form. 
  • Step-Up SIP: This SIP helps you increase your pre-running SIPs. If you have more surplus available in the future and would like to top up your existing premium, this facility would help you. 
  • Trigger SIP: This one becomes active when the market price of your fund reaches a certain point you can fix and then, your SIP gets debited. 

Conclusion

Using SIPs to invest in mutual funds is cheaper, smarter, and easier. Begin today with TradeSmart, an all-in-one solution for all your trading and investing needs. 

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