SIP investments are a great strategy for investing in mutual funds, but it’s not the only strategy. There are many other ways to invest in mutual funds, such as he following:
- Lump Sum Investment: Invest a single, larger amount at once.
- Systematic Transfer Plan (STP): Transfer money regularly from one fund to another.
- Systematic Withdrawal Plan (SWP): Withdraw a fixed amount at regular intervals.
- Timing the market: Invest in different funds at different times for diversification.
- Exchange-Traded Funds (ETFs): Trade diversified portfolios on stock exchanges.
- Direct Investment: Invest directly with the asset management company.
However, we are here to explain why investing in mutual funds through SIP is the best strategy among all. SIP offers numerous advantages that make it the best way to invest in mutual funds, so let us explore them one by one:
1. Disciplined Investing
SIP instills financial discipline, making it easier for investors to stick to their investment goals. With SIP, you commit to investing a fixed amount regularly, typically on a monthly basis. This disciplined approach helps you avoid impulsive investment decisions and ensures that you continue investing even during market volatility.
2. Rupee-Cost Averaging
One of the key benefits of SIP is rupee cost averaging. When you invest a fixed amount at regular intervals, you buy more units of a mutual fund when prices are low and fewer units when prices are high. Over time, this strategy helps you lower your average purchase price, reducing the impact of market fluctuations on your portfolio. Let’s better understand this concept with the help of an example:
Scenario: Investing Rs. 1,000 in a Mutual Fund through SIP
|Month||SIP Investment (Rs.)||Mutual Fund Unit Price (Rs.)||Units Purchased||Total Units Accumulated|
Here, the “Total Units Accumulated” column shows the cumulative units you’ve acquired over time. Now, let’s calculate the average cost per unit:
- Average Cost per Unit = Total Amount Invested / Total Units Accumulated
- Total Amount Invested = 10 months x Rs. 1,000 = Rs. 10,000 Total Units Accumulated = 426.88
- Average Cost per Unit = Rs. 10,000 / 426.88 ≈ Rs. 23.42 (rounded to two decimal places)
Accordingly, your average cost per unit is approximately Rs. 23.42. Even though the unit price of the mutual fund varied significantly during the investment period, your average cost per unit is relatively stable due to rupee cost averaging. This means that, on average, you bought units at a price close to Rs. 23.42 over the ten-month period, reducing the impact of market fluctuations on your investment.
3. Small Investment Amounts
SIP allows you to start investing in mutual funds with a relatively small amount of money. You don’t need a large lump sum to begin your investment journey, making it accessible to a wide range of investors, including those with limited resources.
4. Compounding Benefits
The power of compounding is one of the most significant advantages of SIP. As your investments grow over time, both your initial contributions and the returns generated on your investments earn returns themselves. This compounding effect can significantly boost your wealth in the long run.
For simplifying the concept of compounding, refer to the following table:
|Year||Initial Investment (Rs.)||Annual Interest Rate (%)||Interest Earned (Rs.)||Total Amount (Rs.)|
In the example, after the first year, your initial Rs. 10,000 earns 5% interest, resulting in a total of Rs. 10,500. In the second year, the 5% interest is applied to the new total of Rs. 10,500, earning Rs. 525 in interest and bringing the total to Rs. 11,025. This process continues for each year, with the interest being calculated based on the new total from the previous year.
Thus, compounding results in your investment growing exponentially over time.
SIP offers flexibility in terms of investment amount and frequency. You can increase or decrease your SIP amount, and some mutual funds even allow you to skip a few installments without penalties. This flexibility enables you to align your investments with your changing financial goals and circumstances.
Mutual funds pool money from multiple investors and invest in a diversified portfolio of stocks, bonds, or other assets. SIP allows you to diversify your investments across various mutual fund schemes, asset classes, and market segments. This diversification reduces the risk associated with investing in a single asset or security.
From the above table, it is apparent that eventhough you faced losses of -500 in Mutual Fund B, your gains from Mutual Funds A and C were adequate to cover the loss and provide a return of 500 overall. This is exactly how diversification works.
7. Goal-Based Investing
SIP encourages goal-based investing. By setting clear financial goals such as retirement planning, buying a home, or funding your child’s education, you can tailor your SIP investments to meet specific objectives. This approach ensures that your investments are aligned with your long-term financial aspirations.
8. Accessibility and Convenience
Investing in mutual funds through SIP is convenient and accessible. Most mutual fund companies and financial institutions offer online platforms where you can start, manage, and monitor your SIP investments. This accessibility makes it easy for investors to stay engaged with their portfolios.
The Bottom Line
SIP is undoubtedly one of the best ways to invest in mutual funds due to its disciplined approach, rupee cost averaging, compounding benefits, flexibility, and access to professional management. Whether you are a new investor looking to start your investment journey or an experienced one seeking a systematic and hassle-free approach, SIP offers a reliable and effective way to achieve your financial goals. It’s essential to consult with a financial advisor to determine the most suitable SIP investments based on your risk tolerance and objectives. So, start your SIP today and embark on a journey towards financial prosperity!