What is Systematic Investment Plan [SIP]
What is SIP?
A SYSTEMATIC INVESTMENT PLAN (SIP) is a tool that helps you to invest in a Mutual Fund Scheme in a smart and hassle free way. A SIP is a flexible and easy investment plan.
Meaning of Systematic investment plan
- A SIP is a mode of regular investments in mutual funds. SIP allows you to invest a certain pre-determined amount at a regular interval (weekly, monthly, quarterly, etc).
- A SIP is a planned approach towards investments and helps you inculcate the habit of saving and building wealth for the future.
How does SYSTEMATIC INVESTMENT PLAN work?
- A Systematic Investment Plan is a flexible and easy investment plan. Your money is auto-debited from your bank account and invested into a specific mutual fund scheme.
- You are allocated certain number of units based on the ongoing market rate (called NAV or net asset value) for the day.
- Every time you invest money, additional units of the scheme are purchased at the market rate and added to your account. Hence, units are bought at different rates and investors benefit from Rupee-Cost Averaging and the Power of Compounding.
- With volatile markets, most investors remain skeptical about the best time to invest and try to ‘time’ their entry into the market. Rupee-cost averaging allows you to opt out of the guessing game. Since you are a regular investor, your money fetches more units when the price is low and lesser when the price is high.
- It means you buy the units at different rates and investors benefit from Rupee-Cost Averaging. Thus, you get more units when market is low and less units when market is high and hence market averaging happens. During volatile period, it may allow you to achieve a lower average cost per unit.
Power of Compounding
- Albert Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.” The rule for compounding is simple – the sooner you start investing, the more time your money has to grow.
- Example : If you started investing Rs. 10000 a month on your 40th birthday, in 20 years time you would have put aside Rs. 24 lakhs. If that investment grew by an average of 7% a year, it would be worth Rs. 52.4 lakhs when you reach 60.
- However, if you started investing 10 years earlier, your Rs. 10000 each month would add up to Rs. 36 lakh over 30 years. Assuming the same average annual growth of 7%, you would have Rs. 1.22 Cr on your 60th birthday – more than double the amount you would have received if you had started ten years later.
- Please remember you cannot put the direct compound interest formula on Capital assets (Mutual Funds, stock market etc.)
key features of Systematic Investment Plan
- SIPs are done only in open-ended funds in which the investors can invest and take out the money anytime.
- There is no fixed tenure for running SIP. Even if you select a SIP tenure, if you wish you can stop it in between or you could continue it even after the tenure ends by placing a request with respective mutual fund company. You can also do a perpetual SIP.
- Full and partial withdrawal is possible during or after the SIP tenure is over.
- SIP amount can be increased or decreased.
- Systematic Investment Plan is an ideal tool of Mutual Fund investment for investors earning regular monthly income.
- Systematic Investment Plan is a method of investment in Mutual fund and hence its risk profile is equivalent to the type of asset you invest in.
why to invest in sip?
Benefits of SIP are as follows:
how taxation works on SYSTEMATIC INVESTMENT PLAN ?
- In the case of SIP every investment is considered as a fresh investment. So if you have to get the benefit of long-term capital gains then each investment (SIP instalment) has to be held for a 12-month period in case of equity and for 3 years in case of debt funds.
- Example 1: Equity – SIP invested on 1st Apr 2018 has to be held till 31st March 2019 and SIP on 1st May, 2018 has to be held till 30th Apr, 2019 to get Long Term Capital Gain tax benefit.
- Example 2: Debt – SIP invested on 1st Apr, 2018 has to held till 31st March 2021 to get Long Term Capital Gains tax benefit.
- Things are different in ELSS as there is a lock in of 3 years. Therefore, each investment (SIP instalment) has a lock-in of 3 years. So, if you have done a SIP in an ELSS fund, each instalment will have its own 3-year lock-in. So, investment on 1st Apr 2018 has to be held till 31st Mar 2021 and investment on 1st Mar, 2019 has to be held till 31st Mar 2022.
types of Systematic Investment Plan
Different mutual fund houses provide different types of mutual fund scheme with SIP. But now a days traditional monthly SIP transformed into new varieties of SIP. Let see it. The detailed explanation of each of the type will be covered in the coming articles.
process of SIP calculation : example
- In a SIP, we keep investing regularly over particular period and get back the maturity amount upon exit. We calculate SIP return on monthly basis for 1/3/5/10 year. We used last date of NAV for each month. For example, we made our investment of Rs. 10000 in a fund for period of 5 year in Aug-13 on monthly basis. Then we get certain number of units on basis of nav of 30/8/2013. Hence, we keep accumulated units from 30/8/13 to 30/8/18. On 30/8/18 when we exit the scheme we get maturity amount, which is NAV of 30/8/18 (redemption day) multiplied by total units on redemption day.
- For our SIP calculation we used XIRR Formula. We applied this formula in our calculation for period of 1/3/5/10 year.
- How we calculate:
- SIP amount-10000
- Dates of SIP investments – Last date of each month
- Date of redemption- 1/3/5/10 year
- Maturity (redemption) amount
Steps to calculate SIP using XIRR:
- Step 1- Enter all our SIP dates in one column.
- Step 2 – Enter the SIP amount in another column corresponding to the SIP dates. For example, the SIP amount is Rs 2,000. You will have to enter the amount as -2000. Prefixing a minus sign is important as it depicts outflow of cash.
- Step 3 – Enter the date on which you are supposed to make redemption or the date on which you have made redemption. In front of that enter the redemption amount.
- Step 4 – Apply the XIRR formula =XIRR (B1:B7, A1:A7) *100
Here, B1:B7 is the range of cells of the amounts, and A1:A7 is the range of cells of dates. The result would show the return you have earned on your SIP investments on the date of your choice. On the same basis we also calculate benchmark return & whole category average return for 1/3/5/10 year, so that we can easily compare fund’s performance as compare to benchmark and category average.