What is the role of SIP in financial planning?

Systematic Investment Plans or SIP investments have been getting a lot of traction among Indian investors. The main reasons for this increasing popularity of SIPs are the flexibility offered by this investment approach and rising income levels in India.

Undoubtedly, when it comes to wealth creation, the SIP approach can yield potentially phenomenal results while helping investors stay consistent and disciplined in their investments.
In this article, we will discuss the crucial role SIP investments can play in financial planning and help investors meet specific objectives.

• Table of contents

1. What is SIP?
2. Key SIP benefits that will help in financial planning process:
3. Types of SIPs and their roles in financial planning
4. Role of SIP in financial planning
5. How to start a SIP for effective financial planning

What is SIP?

SIP or Systematic Investment Plan is similar to traditional Recurring Deposits. One main difference between the two is that SIPs are market linked. Meaning, SIP investments allow individuals to invest a specific sum of money in an underlying mutual fund scheme at a pre-decided date of a month. Moreover, investors can also choose the period of investing from quarterly, monthly, weekly, or even daily. However, most salaried investors opt for the monthly SIP investment strategy.

As we can see, SIPs help investors to invest through small, regular instalments rather than investing a lump sum amount. The freedom to invest smaller amounts is one of the main popularity drivers of SIPs in India. To effectively plan your investments, you can use an SIP return calculator. This tool can help you estimate the potential returns on your SIP investments based on your monthly contribution, investment duration and expected returns. You can also adjust the various parameters to arrive at a combination that suits your goals.

Let us look at some more benefits of SIP investments:

Key SIP benefits that will help in financial planning process:

• Flexibility: A Systematic Investment Plan provides you with flexibility of tenure as well as flexibility of investment. Meaning, you can choose the monthly amount you want to invest in a mutual fund scheme as well as the tenure for this investment. The best part is that you do not have to attempt to time the market while investing via SIPs because of the phenomenon of rupee-cost averaging.
• Low starting amount: Unlike a lumpsum investment, an SIP doesn’t require you to commit a large amount to start with. You can begin an SIP with an amount as low as Rs. 100. SIPs, therefore, allow investors to invest however much they can part with while honouring other financial obligations.
• Goal-oriented investments: You can create multiple SIPs each targeted at a specific financial goal. For example, you can invest in different SIPs for marriage expenses, buying a home, paying for children’s education, and so on. Each SIP is structured to optimise the return potential depending on your unique goal and risk appetite.
• Rupee-cost averaging: SIP investments play a crucial role in financial planning because of rupee-cost averaging benefits. When investing through an SIP, an investor will buy fewer units when the market is higher and more units when the market is lower. The rupee-cost averaging phenomenon ensures that your investment is able to mitigate market volatility and generate significant returns over the long term.
• Ease of investing: A common man with limited knowledge about the stock market or mutual funds can also safely invest via SIPs. Setting up an SIP can be done easily online or offline and using a One Time Mandate can automate the periodic investment process. This helps investors adopt a disciplined approach to investing and stay regular with their SIP contributions.
• Power of compounding: The power of compounding is often referred to as the “eighth wonder of the world”. This phenomenon ensures that you earn interest on interest potentially leading to a substantial corpus over a long term horizon. Potentially exponential returns can be achieved once investors understand the significance of compounding and the benefits of staying invested for longer.

Types of SIPs and their roles in financial planning

Here are some different SIP types that mutual fund companies may offer:

• Regular SIP: This is the simplest and most common form, where a fixed amount is invested at pre-defined intervals (daily, weekly, monthly, quarterly etc.). Role in financial planning: It is suitable for investors with a steady income stream, such as salaried individuals, who seek a disciplined, automated route to potential wealth creation in the long term.
• Top-up SIP (or step-up sip): A top-up SIP allows an investor to periodically increase the SIP installment amount, typically on an annual basis and by a fixed percentage or amount. Role in financial planning: This SIP may be suitable for investors who anticipate a rise in their income over time, perhaps through annual increments. It helps in potentially keeping investments in pace with inflation and boosting the potential for compounding over time.
• Flexible SIP (or flexi SIP): A flexible SIP gives the investor the option to increase or decrease their SIP amount based on market conditions or their cash flow situation. Role in financial planning: It may be beneficial for individuals with irregular or variable income, such as consultants, freelancers, or business owners, as it allows them to invest more when they have surplus cash and reduce the amount during lean periods.
• Trigger SIP: A trigger SIP facilitates an investment transaction (purchase, redemption, or switch) only when a specific, pre-determined market event or condition is met. Role in financial planning: This option is generally suitable only for experienced investors who possess a deep understanding of market dynamics and technical indicators, such as a specific index level (e.g., Nifty50 falling below a certain point) or a target net asset value (NAV).
• Multi SIP: The multi SIP option allows an investor to allocate a single, consolidated investment amount across multiple mutual fund schemes of the same fund house using a single instruction. Role in financial planning: This mechanism is primarily a convenience feature that simplifies the process of diversification. An investor may use it to spread capital across different categories to manage overall portfolio risk.

Do note that not every scheme or company offers all types of SIPs. Visit the respective company’s website and read scheme-related documents for details of available SIP facilities.

Role of SIP in financial planning

SIPs play a pivotal role in financial planning by:

• Facilitating disciplined investing: SIPs instill financial discipline by making investing a regular habit. Automating deductions from your income encourages consistent saving and discourages impulsive spending.
• Rupee cost averaging: SIPs help you buy more units when the market is down and fewer units when the market is high. This "averages out" your purchase cost over time, reducing the impact of market fluctuations on your overall investment cost.
• Power of compounding: SIPs allow you to harness the power of compounding. Your initial investments generate returns, and these returns then generate further returns, leading to significant wealth accumulation over the long term.
• Working towards financial goals: SIPs can help work towards various financial goals such as retirement planning, children's education, a down payment on a house, or building an emergency fund.
• Accessibility: SIPs allow you to start investing with small amounts, making them accessible to individuals with varying income levels.
• Reduced stress: Knowing that you are consistently investing towards your future goals can provide significant peace of mind and reduce financial stress.

How to start a SIP for effective financial planning

Here are the steps involved in starting an SIP

• Define specific goals: Determine the purpose of the investment, such as a retirement corpus, a child’s education fund, or a down payment for a home. Each goal should have a specific target amount and time horizon.
• Assess risk appetite: Your ability and willingness to take on risk must be determined before selecting a scheme.
• Select the scheme type: Based on the risk profile and goal horizon, choose the appropriate category, such as large cap, flexi cap, or different categories of hybrid funds. Remember that any fund that invests more than 65% in equity is classified as high risk. For long-term goals (over 7 years), equity funds or schemes with substantial equity exposure (which may be considered high risk) may be suitable, given their potential for long-term growth. For shorter-term goals, debt funds or schemes with a relatively stable profile may be more suitable.
• Complete KYC compliance: Before any investment can be made, the investor must be compliant with the Know Your Customer (KYC) regulations mandated by the government of India. This is a mandatory one-time process.
• Determine investment parameters: Decide on a sustainable monthly or periodic investment amount that aligns with your cash flows. Also, choose the frequency (monthly or quarterly are common) and a convenient debit date.
• Set up the SIP: This can be done online through the website of an asset management company (AMC) like Bajaj Finserv AMC, or through a registered mutual fund distributor or partner. You will need to set up an auto-debit mandate from your bank account to ensure automated, disciplined investments.
• Monitor performance: Regularly review the performance of your chosen scheme relative to its benchmark and peer group, ensuring it continues to align with your financial goals and risk parameters.

Conclusion

Systematic Investment Plan offers a structured approach for investors to meet key financial goals with the disciplined habit of regular investments. Investments made for long duration can yield substantial returns making SIPs an appropriate choice for Indian investors who are focused on financial planning. Moreover, SIPs minimising your risk and can help you meet specific financial goals. With a little patience and diligence, you can start your SIP journey today and make confident strides towards financial independence.

FAQs:

What exactly is a Systematic Investment Plan (SIP)?

SIP is a disciplined investment approach where investors contribute a fixed amount regularly into mutual funds. It promotes consistent investing and harnesses the power of compounding.

How does SIP help in mitigating the impact of market volatility?

SIP allows investors to buy more units when prices are low and fewer units when prices are high, averaging out the cost of investment over time and reducing the impact of market fluctuations.

What factors should I consider when choosing SIPs for my financial goals?

Consider your investment horizon, risk tolerance, and financial goals. Choose SIPs that align with your overall financial plan.

What is an SIP in financial planning?

SIP stands for Systematic Investment Plan, which is a way of investing in mutual funds. SIPs allow you to Invest a fixed amount at regular intervals in a scheme of your choice, promoting discipline and offering the potential to build wealth over time through affordable but consistent investing.

What is the role of SIP?

SIPs offer a structured and disciplined approach to investing by automating regular contributions, helping to potentially build wealth over time. They mitigate the impact of market volatility through rupee cost averaging and harness the power of compounding for long-term financial goals. With small investment amounts and reduced stress, SIPs are an accessible tool for working towards financial milestones like retirement, education, or homeownership.

What is the role of SIP in economic growth?

SIPs play an important indirect role in driving economic growth by channeling individual savings into the capital markets, which in turn supports company expansion and job creation. They promote long-term investment, contribute to a healthy capital market, and encourage financial inclusion, making investing accessible to a broader range of people. Additionally, as individuals build wealth through SIPs, they can spend more, driving demand and thus growth

Why is an SIP plan important?

SIPs are important levers of potential long-term financial success due to their disciplined approach to investing. They are accessible to everyone, allowing small, consistent investments that contribute to long-term wealth creation potential while reducing market timing risks. By promoting regular investing, SIPs can help individuals work towards their financial goals such as retirement, education, and property acquisition.

Can SIP help in retirement planning?

Yes, SIPs can be suitable for retirement planning, providing a disciplined and cost-effective way to build a retirement corpus over time. They allow you to harness the power of compounding, benefit from rupee cost averaging, and participate in the long-term growth potential of the financial market. By starting early and investing consistently, SIPs can offer peace of mind and reduce financial stress in your later years.

How does SIP mitigate risk in my investment portfolio?

SIPs (Systematic Investment Plans) help mitigate risk in your investment portfolio by leveraging rupee cost averaging. By investing a fixed amount regularly, you buy more units when prices are low and fewer units when prices are high, averaging out your purchase cost over time. This reduces the impact of market volatility and minimizes the risk of investing a lumpsum at a market peak.

How much should I invest in SIP for financial planning?

The suitable SIP amount depends on factors such as income, expenses, financial goals, and risk tolerance. A general guideline is to invest 15-30% of your monthly income, but this can vary based on individual circumstances. It's important to start small, invest consistently, and regularly review and adjust your contributions as your financial situation evolves.