SIPs are a way to invest a fixed amount of money at regular intervals (monthly, quarterly, etc.) into mutual funds.
Like clockwork, you invest a fixed amount in a chosen fund at regular intervals (monthly, quarterly, etc.). This approach is good for building discipline and averaging out costs over time, regardless of market fluctuations.
Lump sum mutual funds require a one-time investment of a larger amount. Instead of spreading out your investment, you invest a larger amount all at once. This strategy can be beneficial if you have a windfall and want to take advantage of a specific market opportunity.
Choosing between SIP and lump sum depends on your goals and comfort level with the market. SIP is often recommended for beginners or those who prefer a consistent and automated approach. A lump sum might be suitable for experienced investors who are comfortable with market timing and have a larger sum to invest.
One of the key benefits of SIPs lies in their ability to mitigate risks associated with volatile markets. This is achieved through rupee cost averaging, where you buy more units of a mutual fund when prices are low and fewer units when prices are high. By averaging costs across various market cycles, you benefit from reduced exposure to market fluctuations.
If you are committing to invest Rs. 5000/- in a SIP each month during a market downturn, this amount may buy more units of the mutual fund, maximizing returns when the market eventually rebounds. If you are young (say, 25-year-old) investing Rs. 5,000 per month in an SIP with a 10% annual return could accumulate over Rs. 1.5 crore by the time you retire at 60!
The Power of Rupee Cost Averaging
A study by AMFI (Association of Mutual Funds in India) showed that SIP investors in equity funds earned 12.4% CAGR (Compound Annual Growth Rate) over 15 years (2003-2018), compared to a market return of 11.7%. This demonstrates the power of rupee-cost averaging and consistent investing in volatile markets.
Why choose SIP?
- Maintaining consistent investments is crucial, and SIPs act as a built-in commitment tool. By automating your contributions, you remove emotions from the equation, preventing panic selling during market dips or impulsive buying based on market highs.
- SIPs endorse healthy saving habits. Setting aside a fixed amount each month encourages you to prioritize saving and create a budget that accommodates your investment goals.
- The magic of compound interest is another advantage of SIPs. Your returns are reinvested, creating a snowball effect where your earnings progressively grow over time.
Beauty of SIP
- You can start small and gradually increase your contributions as your income grows. This makes them accessible to everyone, regardless of their financial situation.
- SIPs offer flexibility. You can choose the frequency and amount of your contributions and even pause or stop your SIP if needed. This adaptability allows you to adjust your investments based on changing life circumstances.
- By investing in mutual funds through SIPs, you leverage the expertise of fund managers who research and select promising investments, potentially leading to better returns than you could achieve on your own.
While SIPs can be a convenient way to invest regularly, there are situations where they might not fit your goals. Knowing when to adjust your allocations takes a lot of cheese. Redirecting funds to options with steadier returns can safeguard investments.
In the Indian market, reducing or stopping SIPs helps maintain a suitable asset allocation. Persistent underperformance of a fund demands a re-evaluation. Changes in a fund's strategy or management may require halting SIPs. Life changes, like reduced income, may demand a pause in SIPs.
Inherent risks in mutual fund investment:
We all have watched the mutual fund advertisement on television where, at the end of the ad, it says, ‘Mutual Fund Investments Are Subjected To Market Risks.’
Why? because there are some underlying risks of mutual fund investments which cannot be eliminated, which include:
Market Risk: The jargon which we were talking about in the opening of this blog that ‘Mutual Fund Investments are Subjected to Market Risks’ stands true here. The market risk! All investments depend on the volatility of the market when it goes up the value of capital grows, and the investor faces loss during downmarket scenarios. Therefore, the market risk is inherent in all types of investments. Thus, mutual fund investment are also not free from this uncertainty.
Interest Rate Risk: As the debt mutual funds are inversely related to the interest rate, they always face the risk of rising interest rate in the economy. In case of falling interest rate, the debt mutual funds earn higher returns for the investors. But, the contrary is the case when the interest rate goes up in the economy.
Inflation Risk: Inflation means the gradual increase in the prices of the products and services, at the same time the decrease in the value of products and services. Therefore, mutual fund investments are also not free from the inflationary risk. Rising inflation in the future may lower down the actual value of your returns earned from your investment in the future.
How does SIP dilute volatility?
SIP dilutes volatility by investing a fixed amount of money at regular intervals, regardless of market conditions. This means that during periods of high volatility, the SIP investment amount will buy fewer units of the asset, and during periods of low volatility, the same investment amount will buy more units.
Over time, the average cost per unit of the asset will be lower than the average market price, which can help to reduce the overall volatility of the investment. Additionally, SIP investments can help reduce the impact of market timing risks, as the investment is spread out over a longer period of time.
To illustrate this, let's assume you invest 100 rupees every month in a stock that has a volatile price movement.
| Month 1 | The stock price is 100 rupees, and you invest 100 words. | You get 1 share. |
| Month 2 | The stock price falls to 50 rupees, and you invest another 100 rupees. | You get 2 shares. |
| Month 3 | The stock price rises to 150 rupees, and you invest another 100 rupees. | You get 0.67 shares |
(This is a simplified example, and real-world investments come with additional factors to consider, such as fees, taxes, and diversification.)
Also Read: 9 Best Options to Get Get Funds For Stock Trading In India
Mutual Funds Sahi Hain?
Choosing suitable mutual funds for your SIP is essential. Consider your risk tolerance, investment horizon, and financial goals. Consult a financial advisor if needed.
Remember that SIPs are a powerful tool for long-term wealth creation. By understanding their benefits and incorporating them into your investment strategy, you can take control of your financial future and achieve your financial goals one step at a time.
(Disclaimer: Investing is complex, and past trends do not always predict the future. This article provides educational purposes only. It's not financial advice, nor does it endorse buying shares. Before making any investment decisions, it is smart to do your research and consider talking to a financial advisor.)
