Understanding how SIPs work

A Systematic Investment Plan, or SIP as it is popularly known, has almost become the face of mutual funds. In fact, SIPs and mutual funds are often used synonymously. The two greatly differ, of course, and you can understand their distinctions as long as you know how SIPs work. Keep reading to learn more. 

How does an SIP work?

An SIP is a method of investment that allows you to invest in all types of mutual fund schemes at your chosen frequency.

There are three significant aspects of an SIP:

• Frequency:

  This is the number of times you wish to invest. For instance, you can invest weekly, monthly, quarterly, etc.

• Date:

  This is the day when your money will be invested in the mutual fund scheme. For instance, the 5th of every month.

• Amount:

  This is the amount you wish to invest. For instance, you can invest Rs 1,000 every week.

You can select a mutual fund scheme that aligns with your financial goals and set an amount and frequency. The money will automatically get deducted from your bank account at your chosen frequency and, in turn, get invested in the fund.

For example, if you set up an SIP in mutual fund ABC for Rs 7,000 monthly, the said money will be invested in the mutual fund scheme each month until you stop it. This way, you will be able to invest Rs 84,000 in a year.

Now that you know how SIPs work, understand their benefits, too.

Benefits of SIPs

• Low minimum amounts: 

  SIPs are convenient as they let you invest small quantities of money based on your income and budget. Usually, the minimum SIP amount is only Rs 500, while there is no maximum limit.

• Convenient form of investing: 

  SIPs can be started or stopped any time you want. You can also redeem your money whenever you need it, unless in the case of the Equity-Linked Savings Scheme (ELSS), which has a lock-in period of three years. Moreover, there is no penalty if you stop investing or for missing SIPs. However, this can impact your financial growth and is discouraged.

• Rupee cost averaging: 

  SIPs help you invest for the long term and average out the costs of investment. You get more units when the market is down and fewer when the market is high, thereby balancing out your costs.

• Tax advantages: 

  ELSS, a type of mutual fund, offers tax benefits under Section 80C of the Income Tax Act. You can claim a tax deduction of up to Rs 1.5 lakh per annum. Thus, you get to save up to Rs 46,800 in taxes every year. This benefit is available even through SIPs in ELSS.

• Power of compounding:

   Since SIPs help you invest small amounts of money over the long term, you get to benefit from the power of compounding. The profits you earn are reinvested in the market. Over time, this helps you create wealth.

Conclusion

SIPs are a powerful tool in wealth creation. They have made investing more accessible and affordable. In fact, SIPs can be used by students, professionals, homemakers, and basically anyone who wishes to be financially secure. However, make sure to start an SIP in a mutual fund that serves your purpose and use an SIP calculator to understand the return potential of your investment. 

An investor education initiative by Edelweiss Mutual Fund

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