Risks and benefits of Systematic Investment Plan (SIP)

Investing in SIPs has gained immense popularity over the years. It is one of the most convenient and disciplined ways of investing in mutual funds for long-term wealth creation. However, many investors often question ‘Is SIP safe?’. In this article, we will have a look at the various risks in SIP and evaluate whether is it a suitable investment option for the long term.

This article explains the risks and benefits associated with SIP.

• Table of contents

1. What is SIP?
2. Is SIP investment safe or not?
3. Risks of SIP
4. Benefits of Systematic Investment Plan (SIP)
5. Who should invest in SIPs?
6. Why should you invest in SIP?
7. Factors to consider before investing in SIPs

What is SIP?

A Systematic Investment Plan (SIP) is an investment strategy that enables individuals to invest fixed amounts regularly in mutual funds. Rather than investing a lumpsum, the SIP investment plan allows investors to commit smaller, periodic investments, usually monthly. For instance, consider an individual who invests Rs. 500 monthly in a mutual fund through SIP. This amount is deducted automatically from their bank account and invested in the chosen mutual fund scheme. Over time, these periodic investments accumulate and can potentially generate returns based on the fund's performance.

Is SIP investment safe or not?

All mutual fund investments are exposed to market risk. While SIPs offer a disciplined approach to investing and can mitigate market volatility through rupee cost averaging, they are not immune to risks. Factors such as market fluctuations, economic conditions, and investment choices can impact SIP stability. However, SIPs are considered relatively more stable than lumpsum investments due to their systematic and gradual approach that allows investors to navigate market volatility more effectively. Eventually, the choice to invest depends on individual risk tolerance, investment goals, and proper diversification strategies. Consulting with financial advisors can help evaluate whether SIPs align with one's financial objectives.

Risks of SIP

SIPs are not totally risk-free. Mentioned below are some of the most common risks in SIP investment.

Market risks: Mutual fund schemes, including those invested through SIP, are subject to market risks. Fluctuations in market conditions can affect the performance of the fund, leading to variations in returns.

No guarantee of returns: While SIPs mitigate the risk of market timing, they do not guarantee profits or protection against losses. The returns are dependent on the fund's performance, which can vary.

Inflation risk: Inflation can erode the purchasing power of investments. If the returns generated through SIP do not outpace inflation, it may impact the real value of the invested amount.

Liquidity:SIPs are long-term investment vehicles, and sudden liquidity requirements may pose challenges as they are not designed for quick withdrawals without potential losses.

Benefits of Systematic Investment Plan (SIP)

Apart from long-term wealth creation, SIPs offer several other benefits. Some of them are mentioned below.

Rupee cost averaging: SIPs allow investors to buy more units when the market is down and fewer units when the market is up. This practice, known as rupee cost averaging, helps in reducing the average cost per unit of investment over time.

Disciplined investing SIPs encourage discipline by instilling a regular saving and investment habit. They eliminate the need for market timing decisions, as investments are spread across various market cycles.

Power of compounding: Through regular investments, SIPs reap the power of compounding. The returns earned on investments get reinvested, potentially resulting in significant wealth accumulation over the long term.

Flexibility and affordability SIPs offer flexibility in terms of investment amounts, allowing investors to start with small sums. This makes an SIP accessible for individuals with varying financial capacities.

Read Also: 7 Benefits of Investing in Systematic Investment Plan (SIP)

Who should invest in SIPs?

SIPs can be suitable for a wide range of investors:

First-time investors: SIPs are ideal for beginners due to their simplicity and disciplined approach, helping in creating a habit of regular investing.

Young professionals: Individuals with stable incomes can benefit from SIPs by investing small amounts regularly, leveraging the power of compounding over an extended period.

Long-term investors: Those with a long-term investment horizon can capitalize on SIPs to benefit from market fluctuations and the power of compounding.

Risk-averse investors: SIPs provide a systematic and relatively less volatile investment approach, making them suitable for risk-averse investors seeking stability.

Why should you invest in SIP?

Investing discipline:  Many people find it challenging to develop better habits for investing and saving money. However, with a Systematic Investment Plan (SIP), you can invest a fixed amount at regular intervals, usually every month. You can also set up an auto-debit facility whereby the money is debited from your account on a specified date. This increases your chances of adhering to a timely investing schedule and you can plan your expenses around this, fostering disciplined financial habits over time.

Benefit from the power of compounding: One of the key benefits of mutual fund investments is the power of compounding. Compounding happens when the returns on an investment are reinvested and go on to potentially generate further returns. Over time, this can lead to exponential growth if the investment base keeps increasing. This can lead to significantly growth over time.

Flexibility: Many fund houses offer the option to pause your SIP for a specified period – usually three to six months – without incurring any fines or charges. This can be helpful if you have certain financial exigencies. You can also cancel SIPs if required. However, it is recommended to stay invested to leverage growth potential and compounding benefits.

Factors to consider before investing in SIPs

Before initiating a Systematic Investment Plan (SIP), several crucial factors require consideration. Firstly, assess your financial goals and investment horizon, aligning them with the SIP tenure. Evaluate your risk tolerance and choose a mutual fund scheme accordingly. Understand the fund's track record, expense ratio, and fund manager's expertise. Regularly review and adjust contributions based on changing circumstances.

Conclusion

Systematic Investment Plans (SIPs) present a structured approach to mutual fund investing, offering benefits such as rupee cost averaging, disciplined investing, and the power of compounding. However, investors must acknowledge the associated risks, including market fluctuations, no guaranteed returns, inflation risk, and limitations regarding liquidity. SIPs cater to a diverse range of investors, from beginners to those with long-term investment goals, providing a convenient and disciplined method to achieve financial objectives. To improve your investment planning, using a mf SIP calculator can provide valuable insights into the potential growth of your SIP investments.

FAQs:

Can I change the SIP amount or frequency after starting?

Yes, most mutual fund companies allow investors to modify the SIP amount or frequency. The process differs from company to company.

What happens if I miss an SIP payment?

Mutual fund companies do not usually charge any penalties for a missed SIP instalment. The instalment does not get debited from your account, and your SIP continues with the next scheduled instalment. However, if multiple SIP payments fail due to insufficient funds, your auto-debit instructions may be cancelled, requiring you to set up the process again.

Are SIPs better than lumpsum investments?

The suitability depends on individual preferences and market conditions. SIPs mitigate market timing risks, while lumpsum investments can offer enhanced return potential in some market conditions. You can also use tools like an SIP calculator or lumpsum calculator for help with assessing the potential returns on both investment avenues and plan your approach.

What returns can I expect from SIPs?

SIP returns are influenced by market performance. Past performance does not guarantee future returns, but historically, SIPs have delivered competitive returns over the long term.

Are SIP returns taxable?

Yes, SIP returns are taxable. The taxation of SIP returns depends on the type of mutual fund and the holding period. For equity-oriented mutual funds, if the investment is held for more than one year, long-term capital gains tax (LTCG) is applicable on returns exceeding Rs. 1 lakh at a rate of 10%. Short-term capital gains tax (STCG) at a rate of 15% is applicable if the investment is held for one year or less. Gains from debt-oriented mutual funds are taxed based on the investor’s tax slab.

Is SIP better than FD?

SIPs, especially in equity funds, offer potential for better returns over the long term, with the advantage of rupee cost averaging to mitigate market volatility. However, they come with inherent market risks. FDs, on the other hand, provide stability and guaranteed returns but offer lower returns compared to SIPs in equity mutual funds. The choice between SIPs and FDs depends on factors like risk tolerance and investment goals. You can use a compound interest calculator to assess the return potential of a fixed deposit and compare it with the return potential of SIPs in equity funds.

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.