What you should know about SIPs

Are SIPs a sure-fire way to create wealth? Here are the pros and cons

SIP-Systematic-investment-Shutterstock Representational image | Shutterstock

A systematic investment plan (SIP) is a method of investment that allows you to invest a specific amount at regulated intervals or frequencies (typically monthly) in various instruments, including fixed deposits and mutual funds.

SIPs are popularly associated with mutual funds and over the past decade have become a very popular way to invest.

How do SIPs help create wealth?

In Hindi, they say, “Boond boond se sagar banta hai (drop by drop, an ocean is formed)”. This is much like the principle of SIP.

SIPs build wealth by investing regularly in mutual funds. Every month more than 8,000 crore rupees is invested through SIPs.

Why an SIP makes sense

Kshitija, Director of Gaining Ground Investment Services Pvt Ltd Kshitija, Director of Gaining Ground Investment Services Pvt Ltd

1. You invest a fixed sum at a fixed date. The process is automatically set through Electronic Clearing Service (ECS) from the bank. Through this auto-debit facility, you can keep emotion out of investing. The money goes from the bank to the growing asset.

2. Since you will be investing at different market cycles, your funds will get locked in at different rates (NAV). This helps price averaging.

3. Your fixed salary inflows and SIP outflows match every month, so investment happens systematically.

4. You have the opportunity to build a large corpus by investing small sums regularly. It puts discipline in you. 10-year-plus SIPs can earn handsome returns.

5. SIPs are generally suggested for longer durations of 10, 15 and 20 years. It lowers the cost of investing in longer terms.

6. For a smaller investor looking to minimize market risks and participate in the stock market, SIP is the way to go.

When SIPs do not work

1. The SIP way of investing is very much linked to market and scheme returns—it does not guarantee returns. Investing in a bad scheme regularly does not mean you will get good returns.

2. When equity markets are in a downtrend for longer periods and the economy is under recession for longer periods.

3. SIPs can underperform or you may not get decent returns if the start point is in the upturn of the bull market. But, this is true if the holding period of the asset is relatively short (1-3 years or so).

4. Further, SIPs do not necessarily generate the best results. The ideal investment scenario would be to invest when the market is low, and exit when the market is high. This may not be possible over a long investment period and hence while they may minimize your cost of investment that does not mean that the returns you get would be optimal.

The bottom line

If you are new to investing and your income is regular and monthly, SIPs are the best way to get started and become disciplined. Discipline is a must when it comes to successful investing. An SIP is a good tool for those planning to invest for long term goals like higher education, retirement, and the like. A SIP works best when you have a long time frame in which to stay invested and are not looking for immediate, get-rich-quick returns. If you are willing to park your funds until the market phases—whether bull or bear— can stabilize, an SIP is worth taking a shot at.

The author is Director, Gaining Ground Investment Services Pvt Ltd.