What is SIP in Mutual Fund- Meaning, Benefits, Calculation and Working

A Systematic Investment Plan (SIP) is a type of investment that allows you to make small investments in mutual funds at regular intervals. In fact, you can get started with as little as Rs.1000 instalments and decide the periodic interval at which you would like to invest: monthly, quarterly, and so on. Plus, once you set up your SIP in mutual funds, the investment will be automated, and your instalments will be diverted automatically into your chosen mutual fund on the designated date.
SIPs are a suitable option for both novice and experienced investors since they provide discipline to your investment process. SIPs also encourage the practice of consistent saving and investing. You can also benefit from the power of compounding by continually investing a set amount. Over time, compounding can do wonders. Another advantage of SIP investment is rupee cost averaging.

• Table of contents

1. What is SIP?
2. How does SIP work?
3. Understand SIP with an example
4. How to calculate SIP investment?
5. SIP and rupee cost averaging: An example
6. Types of SIP
7. Features of Systematic Investment Plan (SIP)
8. Benefits of SIP
9. Who should invest in SIP?
10. How to start an SIP investment
11. Things to consider while starting an SIP
12. Taxation of SIP in Mutual Funds
13. Calculate SIP investment return potential by using an SIP calculator
14. How to track SIP performance

What is SIP?

A Systematic Investment Plan (SIP) is a way to invest in Mutual Funds that allows investors to contribute a fixed amount regularly, such as monthly or quarterly, rather than a lump sum. You can start with as little as Rs. 100 or Rs. 500 per month. The deductions can be automated, meaning that the instalment will be automatically debited from the linked bank account on the due date. SIPs can be a suitable way to potentially build wealth over time through consistent contributions. contributing to optimal returns.

How does SIP work?

When you start an SIP, you typically commit to investing a fixed amount at every interval, such as monthly. Your investment is used to buy units in the mutual fund scheme you have chosen. With each investment, you purchase additional units. On the SIP date, the chosen amount is be deducted from your bank account and used to purchase units at the prevailing Net Asset Value (NAV). When planning an SIP, you can use online tools such as the mutual fund sip return calculator to you’re your investments. Based on your SIP amount, tenure, and expected returns, the calculator tells you how much you can potentially earn on your investments. You can try out different values till you arrive at a suitable plan.

Rupee cost averaging

SIPs help mitigate the impact of market volatility through rupee cost averaging. This happens because you invest a fixed amount regularly, regardless of market conditions. So, when the market goes up, you buy fewer units, and when it goes down, you buy more. This approach can mitigate market timing risk, help you capitalise on market dips, avoid investing too much at market peaks, and can lower your per-unit cost over time.

Compounding

Investing a small amount of money regularly over a long period can potentially grow your wealth significantly due to the power of compounding.

The following examples show this effect:

Ravi begins investing for his 60th birthday at the age of 40. Assuming a 7% annualised average return and a monthly investment of Rs. 1500, his total corpus after 20 years can potentially be Rs. 7,20,000.

Ayesha, on the other hand, starts investing for her 60th birthday at the age of 20. With the same annualised average 7% return and a monthly investment of Rs. 1500, her total corpus after 40 years can potentially be Rs. 34,80,000 – nearly five times the amount accumulated by Ravi.

This demonstrates how regular investments over longer periods lead to much higher returns and greater profits.

Do note, however, that these calculations assume a fixed and consistent rate of return. Actual returns depend upon market conditions and are not guaranteed.

Understand SIP with an example

When you invest in a Systematic Investment Plan (SIP), you contribute a fixed amount of money at regular intervals (usually monthly). The number of units you receive for each installment depends on the Net Asset Value (NAV) of the mutual fund at that time.

NAV: The Net Asset Value is the per-unit market value of a mutual fund. It’s calculated by dividing the total value of all the assets in the fund’s portfolio (minus any liabilities) by the total number of outstanding units.

How NAV Fluctuations Affect Unit Allocation:

Lower NAV: When the NAV is lower, you receive more units for the same investment amount because each unit is cheaper.

Higher NAV: When the NAV is higher, you receive fewer units for the same investment amount since each unit is more expensive.

Example:

Let’s say you invest Rs 5,000 each month in an SIP.

Month 1: NAV is Rs 50. You receive 100 units (5,000/50).

Month 2: NAV drops to Rs 40. You receive 125 units (5,000/40).

Month 3: NAV rises to Rs 60. You receive 83 units (5,000/60).

These units are then added to your portfolio, contributing to its growth. The fluctuations in NAV help reduce the impact of market volatility over time.

How to calculate SIP investment?

A SIP calculator makes it easy to estimate the potential returns on your regular mutual fund investments. Based on your monthly investment amount, investment tenure, and expected return rate, the calculator will show you the total amount you’ll invest, your projected returns, and the potential value of your wealth in the future. However, investors should bear in mind that the calculator’s estimates are based on their inputs and there is no assurance that returns will be along expected lines.

SIP and rupee cost averaging: An example

Let’s assume you are investing Rs 1,000 every month. If the NAV for 1 unit is Rs.10, you will be allotted 100 units for the first instalment. If the NAV rises to Rs. 20, you will be allotted 50 units for the second instalment. Conversely, if the NAV falls to Rs. 5, you will be allotted 200 units for the third instalment. Therefore, by the end of the third instalment, you will have 350 units, which comes to a per-unit price of Rs 8.57 (approx.).

Types of SIP

While traditional SIPs are the most common, some asset management companies offer certain variations to add flexibility to SIP investing. Some SIP types include:

Fixed SIP: You can change the end date of your SIP. If you do not specify it, then your SIP would end in 2099.

Perpetual SIP: This is the SIP type where you can keep investing in mutual funds with no end date. You can also ask the fund house to stop the withdrawals whenever you want.

Top-up SIP: You can set periodic increments in your SIP instalments as your income grows. For instance, you can increase your SIP contributions by 10% each year.

Flexible SIP: This SIP type allows you to change each instalment amount or skip instalments based on your preference. You only need to inform the fund house in advance based on the terms of the mutual fund.

Trigger SIP: Instead of investing a fixed amount at fixed intervals, investors can initiate SIPs based on certain triggers linked to market events. For instance, an investor may set up a trigger SIP that initiates an investment when the NAV falls below a certain level. This can help investors time the market even when investing through SIP.

Features of Systematic Investment Plan (SIP)

SIPs offer convenience, affordability and discipline, which can make them attractive to investors. Here are some of the features of SIP:

1. Regular investments: SIPs allow for disciplined and regular investments, making it possible to build wealth over time with affordable but periodic contributions.

2. Rupee cost averaging: By investing on schedule regardless of market conditions, SIPs offer rupee cost averaging, buying more units when prices are low and fewer units when prices are high.

3. Flexibility: Investors have the flexibility to choose the frequency (monthly, quarterly, etc.) and amount of their investments, making it adaptable to their financial situation.

4. Power of compounding: SIPs benefit from the power of compounding, where the returns generated on investments are reinvested, potentially leading to exponential growth over the long term.

5. Affordability: With low minimum investment requirements, SIPs make it accessible for investors to start with small amounts and gradually increase their contributions as their financial capacity grows.

Benefits of SIP

Investing in mutual funds through SIPs can be an affordable and convenient way to build wealth over time through consistency and the power of compounding. Here are some of the benefits of SIP.

Develop discipline: One of the main advantages of SIP investing is that it instils discipline in your approach to investing. You can create a saving and investing habit by committing to a specific investment amount at regular periods. With this methodical approach, you may avoid the temptation to time the market and maintain your attention on your long-term financial objectives.

Flexibility: Another benefit of SIPs that meets the various needs of investors is flexibility. SIPs give you the flexibility to change the investment amount in accordance with your financial capabilities and goals, unlike traditional investing choices. As a result, depending on your financial circumstances, you can change the SIP amount.

Low entry level: SIPs have enabled people who do not have large sums for investment to start investing in mutual funds. The entry level is low, and you can get started for as less as Rs.1000.

Beginner-friendly: Beginners may find it difficult to read market movements for investing a lump sum in mutual funds. SIP creates a relatively stable way for them to do so. Moreover, an SIP allows you to take advantage of rupee-cost averaging since units are allotted for each instalment based on the prevailing NAV, whether the market is up or down.

Who should invest in SIP?

An SIP may be suitable for the following types of investors:

• New or early investors: SIPs allow individuals, particularly those starting their career, to begin their investment journey with amounts as low as ₹500 per month, generally. This affordability makes market-linked investments accessible and potentially helps build a base corpus.
• Investors with regular income: For salaried individuals or those with predictable cash flows, an auto-debit in an SIP ensures that a portion of their income is invested before it can be spent. This automation fosters discipline, which is a potential driver of wealth over time.
• Investors targeting long-term goals: SIPs are suitable for goals with a long investment horizon (typically 5 years or more), such as retirement planning, funding a child’s higher education, or long-term wealth creation. The long timeframe allows the investment to potentially benefit from compounded growth.
• Those who want to avoid market timing: Many investors make the mistake of trying to predict market peaks and troughs, which often leads to delayed investments or emotional decisions. SIPs, which follow a set schedule, do not need to be timed.
• Individuals seeking rupee cost averaging: Through rupee cost averaging, a fixed SIP amount buys more units when the market price (NAV) is lower and fewer units when the price is higher. Over an extended period, this process may potentially help average out the purchase cost per unit and may help navigate volatile markets.
• Spreading deployment risk: Experienced investors, including those with a higher risk appetite, may use SIPs to deploy a large capital amount gradually into a specific scheme, rather than investing the entire sum at once.

How to start an SIP investment

Here are the steps you need to follow to start a systematic investment plan:

1. Define your financial goal linked to your SIP investment.

2. Select the mutual fund house and mutual fund scheme you want to invest in.

3. Choose the SIP instalment amount, investment frequency and SIP time horizon.

4. Set up the auto-debit process from your bank account for SIP contributions.

5. Check your mutual fund account at regular intervals.

Things to consider while starting an SIP

Starting an SIP is not just about picking the right fund; it’s also about aligning your mindset and financial habits to optimise the potential benefits. Here are some considerations:

• Start small, but early: Even if you can’t invest large amounts initially, starting early gives you an edge with compounding. Commit to increasing your SIP contribution as your income grows.
• Be prepared for market fluctuations: Understand that SIP investments are subject to market risks. Stay focused on long-term goals and avoid emotional decisions when markets fluctuate.
• Align investments with cash flow: Set your SIP debit dates close to your income credit dates. This helps streamline cash flow management and prevents missed payments due to insufficient funds.
• Keep realistic expectations: While SIPs can be powerful tools, they are not overnight wealth creators.
• Focus on consistency: It’s better to invest regularly than wait for the ‘right’ market conditions. SIPs thrive on consistent contributions, so prioritise regularity over market timing.
• Account for Inflation: Ensure your SIP investments have the potential to outpace inflation, especially for long-term goals like education or retirement.
• Ensure emergency fund coverage: Before committing to a long-term SIP, maintain an emergency fund. This ensures you won’t need to discontinue or redeem SIP investments prematurely in times of financial stress.

Taxation of SIP in mutual funds

The taxation of investments made through a Systematic Investment Plan (SIP) in mutual funds in India is not treated as a single transaction. Instead, every individual SIP instalment is considered a fresh purchase, and its holding period is calculated independently from the date of investment.

The tax liability arises only when you redeem or sell the mutual fund units. The tax is levied on the capital gains (profit) based on two primary factors:

• The type of fund (Equity or Non-Equity/Debt).
• The holding period of the specific SIP unit being redeemed.

1. Taxation of equity-oriented SIPs

An equity-oriented mutual fund is a scheme that invests 65% or more of its total assets in equity and equity-related instruments.

When the holding period is less than 12 months, the gains are taxed at a flat rate of 20%.

When the holding period is 12 months or more, gains up to Rs 1.25 lakh in a financial year are exempted from tax. Gains beyond this limit are taxed at 12.5%.

2. Taxation of debt-oriented SIPs

These are schemes investing 35% or less in equities. For such funds, all gains are added to the investor’s income tax slab and taxed at their applicable slab rates, regardless of the holding period.

Note: The rates above exclude cess and surcharge.

Important Note for SIPs

FIFO Method: When you redeem units from an SIP, the First-In, First-Out (FIFO) method is applied. This means the units purchased via your earliest SIP instalments are considered sold first. This is beneficial as the older units are more likely to have completed the 12-month period, qualifying for the lower tax rate and the ₹1.25 lakh exemption.

Calculate SIP investment return potential by using an SIP calculator

Online SIP calculators can simplify the process of estimating your potential long-term returns. Here's how to make the most of this tool for both goal-based and current investment scenarios:

These are the steps:

1. Enter the investment amount: Input your preferred monthly SIP contribution. Many schemes allow you start with just Rs. 500.
2. Set the investment tenure: Specify your desired investment duration, or the number of years for which you plan to stay invested.
3. Select the expected return rate: Identify a realistic potential return rate. You can check the average historical performance of your scheme category over multiple time horizons to get an idea. However, it is essential to note that past performance may or may not be sustained in the future and actual returns will depend upon market movements.
4. View your results: The calculator will project the potential value of your final corpus at the end of the tenure.

How to track SIP performance

Since an SIP involves multiple investments over time (each typically at a different NAV), Compound Annual Growth Rate (CAGR) which is commonly used for investment monitoring may not be suitable. Investors may use XIRR, which considers the exact amount and timing of every single cash flow.

XIRR (Extended Internal Rate of Return) is the single rate of return that equates the present value of all your cash outflows (investments) with the present value of your cash inflows (current corpus). It represents your personal annualised rate of return, accounting for the timing and irregularity of your investments.

Conclusion

By now, you know what SIP is in mutual funds and how it is beneficial for all investors. Also, once you set up the auto-debit process, the SIP instalments get debited from your bank account automatically on the specified dates. Through SIPs, even beginners and people who do not have a lumpsum amount handy can invest in mutual funds. Moreover, SIPs help you build the discipline of investing a fixed sum regularly. The best part is that you get the benefit of investing in professionally managed mutual funds in small instalments.

FAQs:

Why should I choose a Systematic Investment Plan?

Choosing a Systematic Investment Plan (SIP) can be beneficial for disciplined investing and achieving your financial goals in a systematic manner. SIPs allow you to invest a fixed amount at regular intervals in a mutual fund, which helps you to average out the cost of investment and benefit from the power of compounding.

What is the best time to invest in SIP?

There is no defined ‘best time’ to invest in SIP. However, the earlier you start investing in SIP, the better corpus you can build in the long run. Since SIPs help average out the cost of investment, it is beneficial to invest in them regularly to achieve your financial goals in a disciplined manner.

Is SIP a good investment option for long-term wealth?

SIPs can be a good option for long-term wealth creation as they can help create wealth through the power of compounding. They also offer the benefit of disciplined investing and averaging out the cost of investment, which can help reduce the impact of market volatility.

How do I start my SIP investment?

To start your SIP investment, you can choose a mutual fund scheme that aligns with your financial goals, risk appetite, and investment horizon. You can then register with the fund house or a third-party investment platform, or distributors to set up your SIP.

Is SIP in mutual funds taxable?

The SIP investments themselves are not taxable, but mutual fund returns (capital gains or dividends) are taxable. The tax amount depends on the type of scheme and holding period of the investment.

How safe is it to invest in SIP?

All mutual fund investments are subject to market risks. Returns or safety of capital are not guaranteed. Some of the investment risks include:

Market risk: The value of investments can fluctuate with market conditions, impacting returns.
Credit risk: Debt funds may face default risks from issuers of securities.
Interest rate risk: Changes in interest rates can affect bond prices, impacting debt fund returns.
Liquidity risk: Difficulty in selling securities can lead to potential losses.
Management risk: Fund manager's decisions may not always yield positive outcomes.
Inflation risk: Returns might not always outpace inflation, reducing purchasing power.

Is SIP better than FD?

SIP and Fixed Deposit (FD) cater to different financial needs. SIPs provide market-linked returns with the potential for better growth over time, whereas FDs offer fixed, stable returns with minimal risk. Your choice should align with your financial objectives and comfort with market volatility.

Can I invest Rs. 1,000 per month in SIP?

Absolutely, many SIPs have a low minimum investment requirement, often starting at just Rs. 500 per month. This affordability makes them an accessible option for a broad spectrum of investors.

What is SIP Rs. 5,000 per month for 20 years?

Your return potential will depend upon your scheme category, whereas actual returns will depend upon market movements and are not guaranteed.

What is the full form of SIP?

Full form of SIP is Systematic Investment Plan. It is a method of investing a fixed amount in a mutual fund scheme at predefined intervals.

What is the minimum amount for SIP in mutual funds?

The minimum SIP amount is decided by each mutual fund scheme and often begins at ₹500. This flexibility allows investors to start small and increase contributions later.

Can SIP be stopped or paused anytime?

Yes, SIPs may be stopped or paused by submitting a request through the AMC or the investment platform. Stopping does not affect existing units. Pausing temporarily suspends contributions for a chosen duration.

Is SIP safe during market downturns?

No mutual fund investment is safe. Mutual funds, including SIPs, are exposed to market movements, so downturns may lead to declines in portfolio value. SIPs simply continue investing at regular intervals and do not protect against volatility.

How is SIP taxed?

Taxation depends on the mutual fund category, not on SIPs themselves. Each SIP installment is treated as a separate investment for tax purposes.

Difference between SIP and Recurring Deposit?

A Systematic Investment Plan invests in market-linked mutual funds, exposing investors to potential gains and market risks. A recurring deposit offers a fixed interest rate determined by the bank. SIP outcomes depend on market performance, while recurring deposits provide predictable returns.

Can I invest in multiple SIPs simultaneously?

Yes, investors may register multiple SIPs across different mutual fund schemes based on risk appetite, goals, and diversification plans. Each SIP operates independently, with separate dates and amounts.

What happens if the SIP payment fails?

If an SIP payment fails due to insufficient balance or technical issues, the AMC may try again within the permitted window. Units will not be allotted for that installment. Repeated failures may lead to SIP cancellation.

Are SIP returns guaranteed?

No mutual fund investment guarantees returns, and SIPs are subject to market risks. SIPs only automate the investment process and offer potential long-term wealth creation opportunities. Portfolio outcomes depend on market performance, scheme category, and holding periods.

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