Mutual fund vs SIP: What is the difference?

Systematic Investment Plans have seen a surge in popularity because of their convenience and affordability. Better known as SIPs, they make investing accessible to people across income brackets, as they enable long-term wealth creation through affordable instalments.

However, a common misconception among those who are new to mutual fund investing is that SIPs and mutual funds are different entities. In reality, an SIP is one of two primary methods of investing in mutual funds, the other being lumpsum.

Let’s take a closer look at what Systematic Investment Plans (SIP) are and the role they plan in mutual fund investments.

• Table of contents

1. What is an SIP?
2. What is a mutual fund?
3. Advantages of investing in mutual funds
4. Advantages of investing in SIPs
5. Lumpsum vs. SIP in mutual funds
6. Factors to consider before choosing between SIP vs mutual funds

What is an SIP?

SIP stands for Systematic Investment Plan. It's a method of investing a fixed amount of money regularly (like daily, weekly, monthly, quarterly, etc.) in mutual funds. The other way to invest in mutual funds is through lumpsum, which is a one-time investment, typically involving a large amount. Here are some key points to know about SIP:

• Regular investment: You invest a specific amount at regular intervals. This means you don't need to worry about timing the market. Whether the market is high or low, your money is invested consistently, making it easier to stay committed to your financial goals.
• Flexibility: You can choose how much to invest and how often. The minimum investment amount for several schemes starts at just Rs. 500, and there is no upper limit. This flexibility allows you to start small and increase your investments as your income grows.
• Disciplined saving: SIP helps in developing a habit of regular saving. By committing to regular investments, you become more disciplined in your financial planning. Moreover, the money can be debited directly from your bank account on the due date. This can be especially beneficial if you find it challenging to set aside money for saving or investing.
• Rupee cost averaging: SIPs help you mitigate the impact of market volatility through rupee cost averaging. Since you invest a fixed amount regardless of market conditions, your investments fetch you more units when prices are low and fewer units when prices are high. Over time, this typically reduces the per-unit investment cost and reduces the risk of investing a large amount at a bad time in the market.
• Compounding benefits: Over time, the returns on your investments can compound, leading to significant growth. Compounding happens when the returns on an investment, when reinvested, go on to earn additional returns. Over time, your money has the potential to grow exponentially over the long-term through compounding. This is what makes it possible to accumulate wealth over time even through affordable investments. The earlier you start, the better it

An SIP calculator online can help you visualise the powerful impact of compounding on your investments. The calculator estimates the potential size of your final corpus based on your SIP amount, expected returns and investment horizon. You can input different investment horizons to see how a longer tenure can potentially result in exponential growth. However, the calculator's estimates assume a fixed rate of return. In reality, returns can fluctuate and depend on market conditions. An SIP calculator with step up feature helps you estimate the returns when you periodically increase your SIP contribution.

What is a Mutual Fund?

Now, let's talk about mutual funds. A mutual fund is an investment avenue that pools money from many investors and invests it in a diversified basket of securities such as stocks, bonds, and other assets. Here are some of the key features of mutual funds:

• Professional management: Investment experts manage the fund, choosing where to invest the pooled money. These fund managers use their expertise and research to make informed investment decisions, aiming to maximise returns for investors over the long term. This means that you do not need to be an expert to start your mutual fund investment journey; mutual fund managers will take care of your portfolio.
• Diversification: Your money is spread across a variety of investments, reducing risk. By investing in multiple assets, mutual funds lower the impact of poor performance of any single investment, providing a more balanced approach to investing.
• Types of funds: There are different types of mutual funds, like equity funds (stocks), debt funds (bonds), and hybrid funds (a mix of both). Each type has its own risk and return characteristics, allowing you to choose one that matches your investment goals and risk tolerance.
• Accessibility: You can invest in mutual funds with relatively small amounts of money. This makes mutual funds accessible to a wide range of investors, including those who may not have large sums to invest initially.
• Liquidity: Mutual funds can be purchased and sold very easily. Most mutual funds offer high liquidity, meaning you can quickly convert your investments into cash if needed, although some funds may apply an exit load or have a pre-decided lock-in period.

Advantages of investing in mutual funds

• Diversification:Mutual funds pool money from multiple investors to invest in a variety of assets, spreading risk across different securities.
• Professional management:Fund managers with expertise handle investment decisions, making it easier for investors to access a well-managed portfolio.
• Liquidity:Mutual funds are generally liquid, allowing you to buy or sell units easily, making them a flexible investment option.
• Affordability:With mutual funds, you can start investing with relatively small amounts, making them accessible for all types of investors.
• Transparency:Mutual funds provide regular updates on portfolio performance, holdings, and NAV (Net Asset Value), offering investors visibility into their investments.
• Regulated investment:Mutual funds are regulated by authorities like SEBI (Securities and Exchange Board of India), ensuring investor protection.
• Tax benefits:Certain mutual funds, such as Equity-Linked Saving Schemes (ELSS), offer tax-saving benefits under Section 80C of the Income Tax Act.
• Flexibility:Investors can choose from various types of mutual funds (equity, debt, hybrid, etc.), depending on their risk tolerance and financial goals.

Lumpsum vs. SIP in Mutual Funds

Let's compare lumpsum and SIP mutual funds:

• Investment method:
  • SIP: It's a way to invest in mutual funds regularly.
  • Mutual funds: It’s a one-time investment in a mutual fund.
• Investment frequency:
  • SIP: You invest a fixed amount at regular intervals.
  • Mutual funds: You invest a large sum at one go.
• Risk management:
  • SIP: Helps in managing market volatility through rupee cost averaging.
  • Lumpsum: Can entail greater risk if the investment is not timed right.
• Compounding:
  • SIP: Each instalment has a different compounding window, with the oldest investment getting the longest market exposure.
  • Lumpsum: The entire investment is exposed to market movements from the beginning, which can optimise return potential in favourable market conditions. On the flip side, wrong market timing can impact returns more significantly.
• Flexibility:
  • SIP: Offers flexibility in the amount and frequency of investment.
  • Lumpsum: Offers flexibility in choosing when to invest, as there is no fixed investment schedule.

Conclusion

Despite misconceptions about SIP vs mutual fund, it’s essential to understand that SIP and mutual funds are not different things. SIP is nothing but a method to invest in mutual funds. If you prefer disciplined, regular investments, SIP is a suitable option. On the other hand, if you have a large sum at your disposal and can take market-timing decisions, you can directly through lumpsum. Both have their advantages, and the choice depends on your financial goals and investment strategy. A lumpsum calculator can help you estimate the potential returns of a lumpsum investment. Bear in mind, however, that the calculator's inputs will be based on a fixed rate of return, while actual returns will fluctuate throughout the tenure depending on market conditions.

FAQs

Is a mutual fund the same as SIP?

No, a mutual fund is an investment vehicle, while SIP is one of the methods of investing regularly in mutual funds.

Apart from SIP, how else can one invest in mutual funds?

The other route to invest in mutual funds is through lumpsum, which is a one-time investment, typically suited for larger amounts.

Which gives better returns, lumpsum or SIP?

The return potential depends on market movements during the investment window. SIPs may be better suited during volatility, owing to rupee cost averaging, while lumpsum may offer higher returns when markets are rising.

Can I withdraw SIP anytime?

If you have invested in an open-ended scheme, you can withdraw from your SIP anytime, but it's best to check the specific terms of your mutual fund for any exit load or penalties.

Is SIP tax-free?

SIPs themselves are not tax-free. Tax treatment depends on the type of mutual fund. For example, equity SIPs held for over 1 year are subject to long-term capital gains tax, while debt funds are taxed based on the holding period.

Which SIP gives the relatively better return?

Equity SIPs typically provide relatively better long-term returns compared to debt or hybrid funds, especially if held for 5 years or more. However, returns depend on market conditions, the chosen fund's performance, and your investment horizon.

What are the risks in mutual funds?

Mutual funds are subject to market risks, including volatility, interest rate changes, and credit risk. The value of investments can fluctuate, and past performance is not a guarantee of future returns. Risks vary based on the type of fund chosen.

What are the risks in SIP?

SIP investments are exposed to market risks, including fluctuations in asset prices. While SIPs help average the purchase cost over time, they do not eliminate the possibility of losses, especially in volatile or declining markets.

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.