Equity Mutual Fund SIP FAQ’s
In a nutshell
Equity based Systematic Investment Plans (SIP’s) are an excellent long term wealth creation tool. Essentially, a SIP is an ‘automatic’ monthly investment of a fixed amount in a mutual fund. The first purchase takes place via cheque, and the subsequent monthly purchases take place directly via an ECS (Electronic Clearing System) request submitted to your bank. You can specify which date of every month you’d like the ECS debit to take place, based upon your individual convenience. By combining three powerful features – namely, Compounding, Rupee Cost Averaging and Discipline, equity SIP’s offer unbeatable potential for long term growth.
Equity SIP’s offer unmatched flexibility. One can tailor make their time horizon, stop and restart the SIP whenever they want and redeem fully or partially in most mutual funds (subject to exit loads). This is where they score over other traditional savings tools such as PPF.
What is Compounding?
Compounding can be best described as ‘returns earned on returns’. By accruing profits within your portfolio over a 10-15 year time frame rather than redeeming (and spending!) the profits periodically, you can reap the magic of compounding, which Einstein termed as the ‘eighth wonder of the world’!
To illustrate with a simple example, a monthly SIP of Rs 10000, when allowed to compound over 25 year time (30 lac saved in total) will grow 6.26 times to 1.9 crore – a profit of 1.6 crore!
In order to reap the benefits of compounding, remember to always opt for the ‘Growth’ option (instead of ‘Dividend’) in your Equity SIP.
What is Rupee Cost Averaging?
Rupee Cost Averaging is a wonderful risk mitigation mechanism. In theory, we all know that we should buy more of something when it’s cheap, and less of it when it’s expensive. In real life, emotions often lead us to do the exact opposite! By investing a fixed sum of money every month regardless of the price of the units, you end up purchasing more during market downturns and lesser units during bullish phases. This ensures that the average buying price of your units is neatly averaged out, thereby providing you with relatively stable growth over the long term.
What is the benefit of Disciplined Saving?
Warren Buffett discerningly advised us to “not save what’s left after spending, but to spend what’s left after saving”. Financial Planning studies over the years have proven that those who save for their goals in a disciplined manner (a fixed amount each month in an inflation beating asset, on autopilot, regardless of expenses) end up taking on fewer loans and achieve their future goals more easily. SIP’s help enforce a disciplined savings habit.
What is the ideal time horizon for an Equity SIP?
In order to fully reap its benefits, an Equity SIP must continue in a disciplined manner (without repeated stoppages and starts) for a period of seven to ten years. One needs to maintain strict discipline and not get carried away by market cycles and break the SIP cycle – as this can impact future returns detrimentally.
Are there any drawbacks to starting a SIP?
Since risk and returns go hand in hand, SIP’s will give you lower returns than lumpsum investments during secular bull markets. Obviously, the volatility will be significantly reduced as well.
The bottom line: Is it for me?
If you’d like to save for a financial goal that’s at least 5 years away (and have a decent risk tolerance threshold), look no further than an Equity SIP! However, if you tend to take emotional investment decisions based on market cycles, you might be better off sticking to a less volatile asset class.
