10 Things You Must Know About SIP

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The primary goal of investing money is to earn more returns from the initial amount. One of the popular investment product for newbie investors is mutual fund. The money invested in mutual fund by investors is further invested in securities like stocks, bonds, money market and other assets. Just as you would thoroughly research before investing in stocks, investors need to research well before investing in mutual funds. 

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Investors looking to invest in a mutual fund can start with SIP (Systematic Investment Plan). SIP allows the investor to invest a fixed amount regularly in a mutual fund scheme. This can be a weekly, monthly, quarterly or annual giving complete flexibility to the investor. When this happens for the long term, the corpus amount accumulates and grows further. For new investors, it is a useful means for investing in a mutual fund. So it is very important to understand SIP.

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Here are 10 things you must know about investing in mutual funds through SIP

1. Start Small

Investing in mutual fund through SIP can start with an amount as less as INR 500.  So it is easily affordable and is less stressful than a lump sum investment. New investors learn to budget and save towards their financial goals. This brings discipline as the money is automatically invested in SIP. It also creates a routine of consistency in investing periodically.

2. Start with a purpose

Before investing in a mutual fund through SIP, you must have a clear purpose. Based on the goal, you can start investing in SIP by choosing a specific mutual fund. You can keep monitoring the performance of the fund and can make changes in SIP if needed. There can be single or multiple SIP associated with the goal. This helps the investor have a clear focus on the goal along with associated target amount and date.

3. Averaging market condition

In SIP you are regularly investing the amount irrespective of market condition. When the market is low, more units of the mutual fund are allocated, whereas when the market is high fewer units are allocated. So there will be sometime when the price of invested money is low and sometime when the price of invested money is high. This is due to that fact some sectors in which the mutual fund further reinvests the money may do well whereas some sectors may not perform well. Over a long term period, this averages out the purchase cost of the mutual fund and helps towards building a large corpus.

4. Changes in SIP

One of the best features about SIP is that you can change the SIP amount or stop an existing SIP. These features are not available in regular RD/FD. Based on an increase in income, SIP amount can be changed in an existing SIP by using a feature called STEP-UP SIP. Investors can also start a new SIP with a different amount. An existing SIP can be stopped at any time and the investor can redeem the accumulated amount. Investors can also pause an existing SIP for a certain period of time and resume it later.

5. Long term investment

The returns projected from SIP’s are generally historical based on past performances. It will not help to get a good return for the short term. A good 15-20 years investing in SIP can help yield a return of 20%. This will help to significantly increase the amount of wealth created through compounding. So SIP is extremely helpful for achieving long term wealth creation goals.

6. Fund selection

With so much popularity in mutual funds, there are many variants of SIP available today. So for the new investor, it gets really confusing on what type of fund to pick for investing. So before investing, there should be good research on the past performance of the fund, expected returns, assets it further reinvests, fund manager and risk factors.  

7. Generating returns vs Wealth creation

Contrary to traditional investing options like Recurring Deposit (RD), SIP is generally used for wealth creation. RD is based on the interest rates fixed by the bank and hence has no risk. Once the duration for which RD has been set up has reached, the invested amount along with the generated interest is credited back to the investor. So RD is a money-saving scheme which generates returns. In contrast, SIP works on the basis of market situations. When investing in mutual funds through SIP, the investor is allocated specific units of the mutual fund based on the invested amount.

So if the value of the mutual fund (NAV) increases, then more units would be allocated to the investor for the same SIP amount. When the tenure of the SIP ends or when you want to stop the SIP, the investor can directly redeem the accumulated units based on the current value of the mutual fund. Hence, while there is some amount of risk in SIP in comparison to RD it is helpful for wealth creation over a longer period of time.

8. Power of Compounding

The best feature of SIP is that investors can take advantage of the compounding power. This means that the wealth created in SIP is not just on the basis of the invested amount but also on the gains that have been generated. For example, if the amount invested by SIP in a mutual fund scheme for a year is INR 100000 and the annual return is 15%, then the invested amount for the next year is 115000 through the same SIP. So by the power of compounding SIP generates higher returns over long period of time.

9. Taxation on SIP

Returns from SIP can be subject to taxation depending on the mutual fund you invest. For equity mutual funds, if you redeem the returns before a year the gains are subjected to short-term capital gains tax. If you redeem after a year of investment, earnings from the fund are subjected to long term capital gains tax. For debt mutual funds, short-term capital gains when redeemed before a year are subject to tax based on the income tax slab of the investor. If you redeem after a year of investment, earnings from the fund are subjected to long term capital gains tax at 20% with indexation. 

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10. Lock In Period and Exit Load

Lockin period is the duration when the invested money is locked in the instrument and cannot be redeemed. If you are investing in mutual fund through SIP, a lock-in period of 3 years is applicable. This means only after completion of 36 months, you can redeem the money from the fund.

Exit load is the charge applied to the investor when they redeem the mutual fund units before the end of the tenure. Most mutual funds have an exit load of 1% if redeemed before a year from investment and no exit load if redeemed after a year from investment.

Conclusion

Therefore have a good understanding of SIP helps the investor to make investments in mutual funds. Similar to any investment product, investors are required to fully understand the product and where their money is invested to fully utilize the benefits and returns with minimal risk.

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