Systematic Investment Plans (SIPs) allow investors to put funds into mutual funds at regular intervals. These regular intervals are often opted for as monthly SIPs, and they promote disciplined investing. SIPs help average out market volatility through rupee cost averaging and encourage wealth creation. This is why MFDs recommend SIP to clients.
1. SIPs Promote Disciplined and Regular Investing Habits
SIPs encourage disciplined savings and investing habits through automation and pre-commitment. Here’s how SIPs inculcate disciplined investing:
- Automation of Investment: The primary mechanism of SIPs is the automatic debit of fixed amounts from the investor’s bank account on a predetermined date each month.
- Habit Formation: The regularity of the investment leads to the formation of a financial habit. Over time, this consistent contribution builds into a significant corpus that reinforces the positive behaviour.
2. Benefits of Rupee Cost Averaging Through SIPs
SIPs are a highly powerful tool to manage market volatility through rupee cost averaging. Here are a few more benefits of SIP for investors:
- Fixed Investment Amount: The investor commits to a consistent, fixed amount for each installment. The amount of money invested remains constant, while the number of units purchased fluctuates with the market price.
- Buying More Units If Markets are Down: If the market is in a slump and the NAV of the fund is low, the fixed investment amount buys a larger number of units.
- Buying fewer units if the markets are up: If the NAV is high, the fixed investment amount purchases a smaller number of units.
- Averaging the Price Over Time: The combination of buying NAV at various price points results in an average cost per unit.
3. Power of Compounding for Long-Term Wealth Creation
With compounding, returns generated on an investment are reinvested to generate their own returns. The mechanism of compounding in SIPs is as follows:
- Returns on Returns: The initial investment made through an SIP generates returns. In mutual funds, these returns are reinvested automatically (unless the fund holder opts for a payout). In the next period, the returns are generated on both the original principal and the accumulated earnings from the previous period. These steps create a snowball effect.
- Time as a Key Multiplier: The longer your investment horizon, the more pronounced the compounding effect.
Illustration of Exponential Growth
To visualise the compounding effect, consider an investor who contributes ₹5,000 monthly via SIP and earns an average annual return of 12%. If the investment is held for three consecutive years, the accumulated return will be 36% and the principal will be approximately ₹1,80,000.
So, the total amount will be approximately: ₹1,80,000 (Investment) + ₹35,396 (Interest)= ₹2,15,396 (Total Value). Investors can also use a SIP calculator to get precise results.
4. SIPs Provide Flexibility in Investment Amount and Tenure
One of the key features of SIPs is the ability to begin investing with a minimal amount. Besides this flexibility, here’s why MFDs recommend SIP:
- Integration with Budgeting: Regular investment amounts can often be managed within a monthly budget.
- Increasing Investment Amount: Many SIP plans offer a feature that allows investors to increase their regular contribution amount periodically.
- Temporarily Pausing Investment: In situations where an investor faces a short-term financial challenge, some options allow for the temporary suspension of SIP contributions for a specific timeframe. This accessibility is useful to manage the budget and help resume SIP when investors are comfortable.
- Modifying or Stopping: Most often, SIPs do not have strict lock-in periods (with some exceptions like tax-savings schemes). This allows investors to modify the investment amount or stop the SIP if their financial needs or goals change.
5. SIPs Help Achieve Diverse Financial Goals Systematically
SIPs integrate seamlessly with goal-focused financial planning by allowing investors to map each investment to a specific objective. These advantages of SIP for clients help to build wealth gradually while keeping contributions manageable.
6. SIPs Are More Affordable and Accessible for New Investors
SIPs offer a low-cost entry point, allowing investors to start with a low amount. This affordability makes them appealing among first-time or experienced investors.
7. Risk Mitigation and Lower Stress Investing with SIPs
SIPs help clients to go through market fluctuations with less anxiety by spreading investments across regular intervals. Additionally, rupee-cost averaging ensures investors get a balanced value of the overall investment.
Conclusion
So, if we have to find an appropriate answer to the question, why SIP is recommended by distributors, let’s say it is for multiple reasons. These include promoting disciplined, long-term investing while managing market volatility through rupee cost averaging. SIPs encourage habit formation, support financial goal achievement and offer flexibility in terms of contribution amounts and investment tenure.