Everybody wants a reward but not risks that come while working towards it. This is human nature. This is also the main reason for the popularity of systematic investment plans, or SIPs, which give investors the option of gaining from market while reducing the risk of volatility that is inherent in all financial markets. SIPs or the good EMI, as they are called by many, help investors avoid the risk of bad market timing, ensure disciplined investing, average out costs, and help investors gain from the power of compounding. We discuss five reasons why SIP is the best way to accumulate wealth in the long term.
Any investment needs a dedicated effort towards achievement of a predetermined goal. However, maintaining discipline in investing is easier said than done if one decides to invest lump-sum amounts. This is because some or the other expense will always come up and distract from goals.
Taking the SIP route is one way to remain disciplined. SIPs allow one to invest a fixed amount at regular intervals – daily, monthly or quarterly. Since in most cases, the amount is automatically deducted from your bank account, this ensures regularity. “SIP ensures that funds do not remain idle in your bank account,” says Lovaii Navlakhi, Founder and CEO, International Money Matters. One can use SIPs to invest in a whole lot of instruments such as mutual funds, stocks, bonds and even gold funds.
TIMING THE MARKET
SIPs, say experts, are a stress-free way of investing. For people who don’t know how to make sense of markets, SIP is a godsend. By committing to regular investing, one can reduce the risk of bad timing in entering or exiting the market. There is always a chance that one stays out when the market is doing well or enters when it is doing badly. SIP takes care of all these worries.
But is there a general rule that someone who is starting a mutual fund SIP for the first time can follow? Yes, one can go by one’s age as the risk appetite is high when a person is young and falls as he grows older and has to fulfil more responsibilities. Aditya Agarwal, CEO, Co-founder, Wealthy.in, says, “Scheme selection and asset allocation should be different for people in different age groups. At a young age, more money should be going into equities, and gradually the percentage of debt should increase as one grows older.”
RUPEE COST AVERAGING
This is one of the biggest reasons why SIPs can be so effective. As markets keep fluctuating, the amount invested will buy you fewer units when they are rising, while the same investment will buy you more units if markets are down/falling. This means the cost of acquisition per unit is averaged out over time. This evens out the market’s ups and downs, especially if one has been investing for long. However, in a bull market, this approach is not likely to be of much use, as the cost of acquisition will keep rising. One negative point of SIP is that the benefits of cost averaging are greatly reduced if markets are not volatile, though in reality this is rarely the case.
SIPs are usually for only open-ended funds and one can take out the invested amount anytime one wants. The amount can be fully or partially withdrawn during the SIP tenure or even later (except in case of tax-saving funds, which have a lock-in period of three years). The amount invested at each interval can be increased or decreased anytime. Though one has to select a period for which one will invest at the time of filling the form, SIPs do not have a fixed period. They can be stopped any time. Also, their tenure can be extended by just requesting the mutual fund company. “Whenever there is a change in income and savings levels, one should review the amount committed to SIPs,” says Navlakhi. To get the full benefits of SIP, experts recommend that one should keep invested for as long as one can. Also, keep in mind that gains from equity investments are tax-free only after one year of the investment. Otherwise, the gains attract short-term capital gains tax of 15 per cent.
BENEFITS OF COMPOUNDING
Financial planners say one must start an SIP as soon as one can to gain from the effect of compounding. Even a delay of a few years can make a significant difference to the wealth accumulated. In long-term investments, one benefits immensely from the power of compounding as one earns interest on the accumulated interest. “Compounding is linked to the rate of return and the number of years. SIP is able to help you gain from compounding in a way that is decoupled from market volatility,” says Agarwal. Another benefit of SIP is that one does not have to invest a huge amount; one can start by investing as little as `500-1,000.
To gain from all the above factors, one must make sure that a portfolio should have investment vehicles that can give returns higher than the inflation rate over long periods.