Working out early morning is a good activity as it reenergizes the mind and loosens all the stiffness from the body. However, one can only reap benefits if they are consistent with their workouts and do them every day. Something similar is the case with the Systematic Investment Plan (SIP).
There are two ways in which investors can invest in mutual fund schemes – they can either make a one-time lump-sum investment or they can opt for the Systematic Investment Plan option. The exercise of being regular with your SIP investments can prove to be healthy for your long term financial goals.
Let us first understand the differences between SIP and lump-sum –
Lump-sum: In lump-sum investing, the investor has to invest the entire investment sum right at the beginning of the investment cycle. They do not have to worry about investing every month as they will be buying all the units at the mutual fund scheme’s existing NAV all at once. However, there is a huge investment risk especially if you are investing in equity mutual funds as you will end up exposing your entire investment sum to the dangers of unpredictable and volatile equity markets throughout the investment period.
Systematic Investment Plan: The whole idea of opting for SIP so that you do not have to pay the entire investment sum right at the beginning of the investment cycle. Investors can zero down to a fixed sum and invest this sum monthly in a mutual fund scheme of their choice. Also, not everyone has a large surplus to commence their investment journey. Such individuals can consider investing in mutual funds via SIP as well. While most investors opt for the monthly SIP option you can also consider weekly, quarterly, biannually, or annually. If you continue to invest in mutual funds via SIP regularly without being inconsistent, you may even be able to achieve your long term financial goals faster than anticipated.
How does SIP boost your mutual fund portfolio?
First and foremost, if you automate your SIP transactions you do not have to worry about making manual investments every month. For those who give their consent to the AMC and to their bank, every month on a fixed date the predetermined SIP sum is debited from the investor’s savings account and electronically transferred to their mutual fund portfolio. Based on the SIP sum and the current NAV investors are allotted units. This is a good way to inculcate the discipline of regular investing as one does not have to worry about making month-on-month manual SIP investments.
Power of compounding
When you commence your investment journey you may wonder how you will achieve your goals with such small monthly SIP investments. The answer is the power of compounding. Every time you earn interest on the sum that you invested, if you do not redeem these gains and allow them to get reinvested back in the fund, over a certain period of time, these returns start generating interest of their own. This is referred to as the compounding effect which has the potential to turn your small investments into a large corpus.
Rupee cost averaging
One of the biggest advantages which SIP has over lump-sum investing is rupee cost averaging. When the NAV falls investors can buy more units from their SIP investments. Similarly, when the NAV rises investors buy fewer units. This way investors average out the cost of purchase and are able to buy more units in the long run. Rupee cost averaging does not just reduce the investment cost, but also reduces the overall investment risk.