Generally, it has been noticed that investors try to co-relate between these two words - mutual funds and SIPs and gets confused that how systematic investment plans, also called SIPs, actually work and make your investments profitable. Therefore, before making any investment, you as an investor should understand what a mutual fund is and how doing systematic investment planning helps you to achieve your financial goal over a period of time.
To understand how SIPs work in mutual funds, let us first briefly know what mutual funds itself stand for. A mutual fund is a financial instrument, which comprises of several schemes where you pool your money along with other investors’ money, which then gets invested in stocks or bonds or a mix of the two (both stocks and bonds), depending on the type of mutual fund scheme you choose.
The total investment made by a mutual fund, either in stocks/bonds, is then divided into units. You get units, based on the proportion of your investment (money you invest in the mutual fund). The value of the mutual fund is measured by its Net Asset Value (NAV). This is the value at which you (investor), buy and sell mutual funds.
Systematic Investment Plan and its working mechanism
SIPs are a method of investing in mutual funds. You invest a certain pre-determined amount at a regular interval in the mutual fund. This might be once each week, once each month or once in a quarter. If you have given ECS mandate, money will be automatically debited from your bank account and invested in the mutual fund scheme of your choice. Units of the mutual fund scheme are allocated based on the NAV (Net Asset Value) of the scheme for that day.
How are SIPs related to mutual funds?
C.S. Sudheer, founder, indianmoney.com, said mutual funds are a professionally managed trusts, where money invested by you and other investors are pooled and invested in stocks, debt or a mix of stocks and debt, depending on the type of mutual fund. SIPs are just a method of investing in mutual funds and to understand better, one should know these difference between mutual fund and SIPs:
=> Mutual funds are an investment. SIPs are a method of investing in mutual funds.
=> Though SIPs are often associated with mutual funds, you can even invest in stocks through SIP.
=> SIPs are like EMIs you pay on loans but in the opposite direction. “Just as you pay EMIs each month towards loan repayments, in much the same way, SIPs are a method of investing regularly in a mutual fund,” he added.
How you get benefited from SIP?
It is a smart and hassle-free method of investing in mutual funds. Through SIP you can invest a certain, fixed, pre-determined amount at regular intervals of time like once a week, month or quarter. Doing so, SIPs give you the twin major benefits of rupee cost averaging and the compounding benefit:
Rupee Cost Averaging: With SIPs you don’t have to time the market. Rupee cost averaging helps you avoid the guessing game. SIPs encourage regular investing in mutual funds and your money fetches more units if NAV is low and fewer units if NAV is high. SIPs are an excellent way of investing, especially when markets are down, as you accumulate more units which help build a sizeable corpus with time.
Power of compounding: If you invest in mutual funds via SIPs the returns you get earn returns and this is the compounding benefit. SIPs encourage long-term investing in mutual funds as earnings get re-invested giving even higher returns.