Understanding the difference between SIP and traditional saving methods

When it comes to savings and investments, understanding the various approaches is important for making informed decisions. Among the many popular methods of investment is the Systematic Investment Plan (SIP), which is known for its unique benefits. Traditional saving methods, on the other hand, have been the foundation of personal finance for generations. Some of the traditional saving methods include savings accounts, fixed deposits, and recurring deposits, each characterised by their simplicity and stability.

Let’s take a look at some of the key features of SIP vs. traditional investments.

• Table of contents

1. What is Systematic Investment Plan (SIP)?
2. What are traditional saving methods?
3. SIP vs. traditional saving methods: Key differences

What is a Systematic Investment Plan (SIP)?

An SIP is a method of investing in mutual funds. It allows investors to invest a fixed amount regularly, typically monthly or quarterly, into a chosen mutual fund scheme. SIPs offer a disciplined approach to investing, and the habit of investing regularly can help build a significant corpus over time. The feature of rupee cost averaging in SIPs means that more units are purchased when prices are low and fewer units when prices are high, which averages out the cost of investment and can potentially lead to better returns in fluctuating markets.

Moreover, SIPs offer the flexibility to start with a small amount, making them accessible to a wide range of investors. They also allow investors to increase their investment amount as their income grows. This aspect, combined with the potential for higher returns – thanks to the compounding effect – makes SIPs an attractive option for young investors and those looking to build a substantial retirement fund. Investors can use an SIP calculator online to estimate potential returns based on their SIP amount, expected returns and investment duration. This can aid them in decision-making.

Additionally, certain SIPs in Equity Linked Saving Schemes (ELSS) also offer tax benefits under Section 80C of the Income Tax Act, which is an added advantage over most traditional saving methods. A variant of the traditional SIP is top up SIP. This facility allows you to automatically increase your SIP contributions by a fixed percentage at regular intervals. Over time, this can significantly boost your invested capital and thereby, return potential. A top up SIP calculator can help you visualise the growth potential of this approach vis a vis a regular SIP.

What are traditional saving methods?

Traditional saving methods, such as savings accounts, fixed deposits (FDs), and recurring deposits (RDs), are known for their stability and predictability of returns. While savings accounts also offer liquidity and ease of access, FDs and RDs provide fixed returns over a predetermined period. Here’s an overview of these traditional savings options.

• Savings accounts: These are bank accounts where individuals can deposit money and earn a nominal interest. They are considered a safe place to park money, offering access to funds. Salaries are usually credited to these accounts and the money is used for daily expenses.
• Fixed deposits: These are financial instruments offered by banks where a sum of money is locked in for a fixed period and earns a fixed and pre-determined interest rate. Fixed deposits provide higher returns than savings accounts and are considered low-risk. However, they do not typically provide liquidity, as investors may incur a penalty if they withdraw the money before the tenure ends.
• Recurring deposits: Recurring deposits are schemes where individuals deposit a fixed amount regularly over a specified period and at a pre-determined interest rate. Upon maturity, the individual receives the invested principal, and the interest earned. They encourage disciplined savings.

SIP vs. traditional saving methods: Key differences

Let us compare the two types of saving methods from the perspective of growth, diversification, risk, liquidity, and suitability for investors.

Potential for growth

SIPs are linked to the stock market, which is why they offer a higher potential for growth compared to traditional saving options. When the stock market is volatile, SIPs benefit from the concept of rupee cost averaging, which can potentially lead to higher returns in the long run. In contrast, traditional saving methods offer fixed and predictable returns but generally at lower rates. This makes them less suitable for long-term wealth creation due to the erosive effect of inflation, but ideal for short-term savings and emergency funds.

Diversification

SIP in mutual funds inherently offer diversification as they invest in a variety of stocks or bonds, depending on the fund’s objective. This reduces the risk compared to investing in a single stock or bond. In contrast, traditional saving methods do not provide diversification as they are not linked to the stock market.

Risk factor

While SIPs are subject to market risks, choosing a fund with a good track record and investing over a longer period can mitigate some of these risks. Additionally, there are various types of mutual funds, including debt and hybrid funds, which offer different levels of risk. However, traditional saving methods are considered safer as they are not subject to market fluctuations. They are more stable but offer limited growth potential.

Liquidity

SIPs offer moderate liquidity. Investors can withdraw their investment, but it might be subject to exit loads or market conditions depending on the type of fund invested in. Traditional saving methods like savings accounts offer high liquidity, whereas fixed and recurring deposits have a fixed tenure, making them less liquid.

Read Also: Evaluating liquidity risk in large and mid cap funds

Suitability for investors

SIPs are suitable for investors looking to build wealth over a long period, are comfortable with some level of risk, and wish to benefit from the growth potential of the stock market. Traditional saving methods are ideal for conservative investors who prefer stability and guaranteed returns, even if they are lower.

Conclusion

While traditional saving methods offer safety and predictability, SIPs provide a dynamic and potentially more rewarding path to wealth creation. Understanding the features and benefits of each type of investment method can help investors make choices that align with their financial goals and risk appetite.

FAQs:

Is a SIP better than a traditional saving method?

The answer varies based on your financial goals and risk tolerance. SIPs offer higher growth potential but with increased risk, while traditional methods are safer but with limited growth potential.

Can I lose money in a SIP?

Yes, because SIPs invest in the stock market, there is a risk of loss, especially in the short term. However, investing over a long period can potentially mitigate this risk.

Are traditional saving methods completely risk-free?

While they are considered relatively stable, factors like inflation can affect the real value of the returns from traditional saving methods.

What is the difference between SIP and regular investments?

SIPs are a way of investing in mutual funds. Other investment avenues can include direct investments in the stock markets, lumpsum investment in

Will I get my money back if I cancel my SIP?

Once your SIP cancellation is processed, subsequent payments will stop. You can then redeem your investments as per their current market value (which may be higher or lower than your invested amount, depending on market conditions. You can also choose to stay invested (without investing additional funds). The amount you have already put in through SIPs can continue to earn potential returns based on market movements.

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.