Is SIP investment a suitable choice? The benefits and drawbacks

A Systematic Investment Plan (SIP) allows investors to regularly invest small sums of money into mutual funds or stocks. SIPs provide a structured approach to investing for reaching long-term financial goals. This article examines whether investing through SIPs is suitable for investors or not.

• Table of contents

• What is an SIP?
• Why is SIP a suitable investment vehicle?
• Is SIP suitable for every investor?
• Common myths and misconceptions about SIP investing
• Common mistakes to avoid with SIP investing

What is an SIP?

An SIP or Systematic Investment Plan refers to periodically investing a fixed sum in a mutual fund scheme or stock. The investment amount can be as low as Rs. 500 per month in general. SIPs allow buying units of mutual funds or stocks at different prices over time. This averages out the purchase cost, a strategy called rupee cost averaging.

SIPs help inculcate investing discipline as the funds get deducted automatically on a set date. This approach counters emotional investing decisions based on market fluctuations.

Why is SIP a suitable investment vehicle?

Investing through SIPs has several benefits that make it a suitable investment strategy, especially for retail investors.

Facilitates regular investing

SIPs promote investing discipline as they deduct a set amount at regular intervals. Investors don't need to manually invest each time. This approach helps counter lack of financial planning.

Manages volatility through rupee cost averaging

Investing at different market levels averages out the acquisition cost. This mitigates risk from market volatility compared to lump sum investing.

Power of compounding

Investing early and regularly builds a corpus over time through compounding. Even small SIP investments may grow to large sums in the long run.

Suitable for different risk appetites

SIP in equity funds may suit investors wanting relatively higher market-linked return potential in the long term. SIPs in debt funds may provide relatively stable returns for risk-averse investors. One can choose SIPs based on investment horizon and risk tolerance.

Low investment amount

SIP investment amounts can be as low as Rs. 500 per month in general. This allows participation across income levels, even for low surplus investors.

Automatic reinvestment of Income Distribution cum Capital Withdrawal

IDCW earned from the mutual fund scheme can be reinvested automatically to purchase more units subject to selected plan. This can accelerate wealth creation.

Situations where SIP may not be suitable

Despite the many positives, SIPs may not be suitable in certain situations.

Short investment horizon

SIPs require longer duration of 5-7 years to be effective. Investors with short 1-2 years horizon may be better off choosing one-time investments.

High transaction charges

Some mutual funds deduct high transaction charges for SIP investments. This reduces net investment amount, impacting returns.

Inflexible installment date

Most SIPs offer fixed date investments only. Sudden requirement of funds on other dates is difficult to manage with SIPs.

Market timing opportunities

SIPs may underperform compared to tactical investing during prolonged bearish or bullish trends in stock markets.

Is SIP suitable for every investor?

While SIPs may suit many investors, one must assess aspects like investment goals, time horizon, risk appetite, and lumpsum availability before deciding to invest through SIPs.

They may be suitable for investors who:

• Want to accumulate wealth gradually
• Are starting late and need to compensate through disciplined investing
• Have moderate risk appetite and return expectations
• Desire low monitoring of investments
• Prefer hands-off approach allowing professional management

SIPs may not be suitable for:

• Investors wanting absolute short-term capital preservation
• Traders preferring to time the markets
• Investors possessing large lumpsum funds and want bulk investing
• Those with very high or low risk tolerance

Common myths and misconceptions about SIP investing

Despite SIP's benefits, some common misconceptions deter investors from using them.

SIPs guarantee good returns

SIP returns depend on underlying asset class and may carry risks. They do not necessarily assure positive returns.

SIPs lock-in money for long periods

Investors can stop SIPs anytime provided due notice is given to the fund house. The invested corpus can also be redeemed, subject to exit load if applicable.

SIPs require large monthly investments

Even small amounts like Rs. 500 per month in general can be started as SIP.

SIPs tie money with just one fund house

One can spread SIP investments across different fund houses and mutual fund schemes. This provides diversification.

SIPs cannot beat direct equity investing

Equity SIP returns can match and may even exceed returns of direct equity investing in the long run owing to rupee cost averaging and compounding.

Common mistakes to avoid with SIP investing

Some common SIP investing pitfalls, if avoided, may enhance investor experience and boost returns.

• Not increasing SIP amount at least annually with income rise
• Poor selection of mutual fund scheme not aligning with goals
• No periodic review of fund performance and reallocation if required
• Investing for too short 3-5 years duration insufficient to realize SIP benefits
• Redeeming SIP corpus to meet short-term needs instead of goal
• Stopping SIP midway due to market correction and volatility
• Choosing SIP date close to major monthly expenses depleting bank balance

Conclusion

SIP can be a suitable investment vehicle for retail investors to systematically invest in mutual funds and stocks. By enabling disciplined investing, SIPs counter emotional decision making and help you benefit from market volatility. SIPs suit investors having moderate risk appetite and return expectations over long durations. However, they may not be appropriate for short-term investments and immediate lumpsum needs. Avoiding common misconceptions and mistakes can provide positive SIP investing experience. Evaluating aspects like time horizon, liquidity needs, and risk profile can help decide suitability of SIPs for specific investment objectives.

FAQs:

Is SIP safe for investment?

SIP invests in equity mutual funds which carry some risk. However, by averaging purchase cost through fixed investments, SIP somewhat mitigates risk compared to direct equity purchase. Longer timeframes of 7-10 years aid in managing volatility.

Is SIP better than FD?

SIP has potential to deliver higher inflation-adjusted returns as compared to FDs. However, SIP carries some risk compared to almost zero risk for FDs. SIP may be better for investors wanting market-linked returns despite some risk.

Is SIP tax-free?

No, SIPs do not provide tax exemption. It is taxable according to the scheme you invested in. However, schemes such as ELSS offer tax exemption up to a certain limit annually.

How is SIP beneficial to investors?

SIPs inculcate financial discipline through automated fixed investments. Rupee cost averaging manages market volatility, and compounding boosts returns. Minimal paperwork and monitoring aid convenience.

Can I lose money in SIP?

Yes, investor capital and returns are not guaranteed with SIP. The underlying mutual fund scheme's performance drives SIP returns. Prolonged bearish equity market trend can lead to sub-optimal investment outcomes.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.