Why an SIP is one of the best tools for building wealth

Bhavana AcharyaFundsIndia.comIf you have ever looked up retirement calculators, chances are that seeing the size of the corpus you would need, left you reeling. How are you supposed to build up a corpus that runs into crores? Well, little drops of water make an ocean, and putting a systematic investment plan (SIP) in place will help you get to your goal eventually. Here are three ways through which an SIP makes a difference.First, it lets you gradually save up. Let’s say you are 35 years old right now, and spend Rs 30,000 each month. You would need a corpus of Rs 3 crore at the time of retirement, which can take you through the next 20 years. That’s quite daunting a figure. But break it down into monthly investments – in other words, start an SIP, where you put away money each month. Monthly savings of around Rs 15,000 will get you to your goal, assuming reasonable annual returns of 12 per cent. The goal seems a lot less daunting now, doesn’t it? The point is that most financial goals – be it children’s education, down payment for a house, and so on – involve large corpuses. It’s hardly possible for us to save lakhs at a time, which is what lump-sum investing is all about. In an SIP, investments can start as low as Rs 1,000. This amount can be progressively increased as your salary and surplus grows. In this manner, an SIP lets you build up to this amount gradually.Second, it makes it easier to save. An SIP does not need you to have the smarts to time markets. An SIP simply introduces regularity in investing. Because it is automated, you don’t have to remember to invest each month yourself. It allows you to draw up a clear budget for your expenses and other savings too.So set an SIP at the start of the month, when you have a plump bank balance. Once the SIP is done, you can splurge for the rest of the month with a clear conscience! Allowing a SIP to continue will also eliminate the tendency to sell when markets turn gloomy, which can scupper your wealth building.Third, it makes bear markets work to your advantage. When markets take a turn for the worse, continuing with your SIP lets you average the cost of your investments lower. You are in effect striking bargains by buying more when markets are cheaper, thereby staying true to the maxim of buying low. In the past two decades, barring the bull run of 2003-2008, market cycles have generally lasted around two to three years. Therefore, it’s important that you continue your SIP especially when markets are correcting, as that is the best phase for averaging out costs.In a SIP, investments will be made at regular intervals - ideally, every month. Therefore, when markets slide, there is more unit accumulation at lower NAVs. This leaves you with a higher number of units when markets pick up again, therefore improving overall return. You benefit from the effect of compounding. Let’s assume you started a SIP in an equity fund (HDFC Equity used for illustrations below) for Rs 5000 in October 2010, when markets had already rallied after the 2008 crash. Look at the graph below. It shows how units accumulated would have risen as the market yo-yoed in the past five years. Also, it pulls the cost of investment lower. Continuing the first example, the graph below shows how the worth of your investment surges far ahead once the proper 2013 rally took root after years of dithering. The yield on your investment works out to 14.6 per cent. Not bad, is it? Past returns are not indicative of future performance. Mutual funds are subject to market risks. Please read the scheme information and other documents before investing.