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Systematic Investment Plan

Updated on March 28, 2024
Article byAswathi Jayachandran
Edited byAswathi Jayachandran
Reviewed byDheeraj Vaidya, CFA, FRM

What is a Systematic Investment Plan (SIP)?

A Systematic Investment Plan (SIP) is an instrument that aids in making regular investments. It is more pronounced in the equity mutual fund schemes. They help in averaging purchase costs and maximizing returns. However, it mainly aids in building a large corpus to achieve long-term financial goals with regular small investments.

SIPs allow investors to spread out buying costs and increase returns. When the market is low, SIP will buy more units than when the market is high. If invested regularly over time, regardless of market conditions, it can average the buying cost of investments. Choosing the best systematic investment plan will offer good returns and disciplined investing.

Key Takeaways

  • A systematic investment plan assists the investor in constructing an investment portfolio over time by making small contributions regularly. As a result, market volatility is reduced by making small, regular payments at predetermined periods. 
  • The investment money is generally auto-debited from the investor’s bank account, and the matching number of mutual fund units is given based on prior instructions. The plan’s current Net Asset Value (NAV) determines the number of units received.
  • SIPs offer greater investment diversity, flexibility and tax advantages, and higher rates of return than FDs. However, it is not suitable for those with irregular income, does not function their best in bullish markets, and payment breaks are not possible.

Systematic Investment Plan Explained

Systematic Investment Plan

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A Systematic Investment Plan aids the investor in building a portfolio over a long period. The issue of the matching number of mutual fund units is based on prior instructions for the planned amount. The received amount of units is determined by the plan’s current Net Asset Value (NAV).

Stock selection and determining the best entry price are important aspects of equity investing. An equity systematic investment plan helps investors minimize the risks of market timing and facilitates wealth growth in a disciplined manner. Making small and regular payments at designated intervals reduces the risk of market volatility. In addition, it promotes portfolio growth by averaging investment costs. Small deposits made in intervals are the key to building a large amount with the power of compounding.

The investor can choose a SIP, either amount-based or quantity-based

Amount-based SIP:

The investment is a fixed amount as the investor decides, and the investor also gets to choose the frequency of payments. The time for which the amount is invested is usually calculated by dividing the amount by the market price.

Quantity-based SIP

This is a type of SIP in which a person purchases a predetermined number of shares of the selected firm at a predetermined frequency. In a quantity-based SIP, the quantity to be bought is specified, and it is fixed while placing orders at the investor’s desired frequency. The stock’s current market price determines the order value when executing the order.

Various investment options include systematic investment plans in mutual funds, stocks, ETFs, and gold. The investor shall choose the best systematic investment plan after a thorough understanding of the market and the risks. A systematic investment plan calculator can help the investor make the appropriate investment choice. The systematic investment plan calculator considers the monthly investment amount, the duration, and interest rate to conclude.

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Examples

Example #1 – Calculation of SIP

M = P [(1+i) ^n-1]/i)*(1+i) is the formula used to calculate SIP.

Where M is the amount investor receives in the future at maturity, P is the invested amount invested through SIP; i is the Compounded rate of return, n is the Investment duration in months, and r is the Expected rate of return.

Suppose Jay wants to invest $2,000 per month for 24 months for a 12% annual rate of return (r). Then we can do the calculation as follows:

i = r/100/12 or 0.01.

M= 2000 * [(1+0.01) ^24 – 1] * (1+0.01)/0.01=54486

Jay’s Profit (Estimated returns) = Maturity amount – invested amount ($2000*24)

= $54486-$48000

=$6486.

Example #2 – Illustration of the compounding power of SIP

Given below are systematic investment plan returns from a monthly investment of $2000 over specific years.

Particulars4 years8 years16 years
Invested amount$96,000$1,92,000$3,84,000
Estimated returns$27,670$1,31,053$7,78,756
Total value$1,23,670$3,23,053$11,62,756

It is clear that systematic investment plan returns are increasing as the term of the SIP increases.

Advantages & Disadvantages 

The following are a few of the advantages and disadvantages of SIPs.

Advantages

  • Reduced stress: Investors do not have to worry about determining the best time to buy stock. Transferring money and buying is automatic, and hence there will be less stress.
  • Disciplined payments: The payments are in the form of small regular payments; the amount gets debited automatically, and the investor has to ensure that the amount is available in the bank account. They also have protection from making emotional decisions based on market sentiments. This makes them disciplined investors.
  • Compounding: The small amounts contributed each month may not be heavy on the investor’s pockets. When these small amounts start gathering interest, and over time, the total returns grow.
  • An easy investment: They require only small amounts, and investors would not feel pressured to set aside huge funds. This encourages saving.

Disadvantages

  • Not suited for individuals with irregular income: SIPs best suits the individuals who have a steady flow of income. They have to make consistent payments to ensure maximum results from the investment.
  • Breaks: Payment breaks are not possible. If the investor wants to move that amount for an emergency, it won’t be easy. Cancellation may be the only resort due to which investors may have to incur penalties.
  • Bullish markets: In bullish markets or when the market goes up, SIP investments do not function at their optimum. When the market rises and continues to increase over time, the units purchased are worth more than the preceding one, resulting in a higher average value than the initial lump sum investment.

Frequently Asked Questions (FAQs)

How does a systematic investment plan work?

SIPs work based on prior instructions, the investment amount is normally auto-debited from the investor’s bank account, and the matching amount of mutual fund units will be allotted. The amount of units received is determined by the current Net Asset Value of the plan (NAV).

How is SIP calculated?

SIPs are calculated by considering factors such as the monthly payments, interest rate, and duration. The investors can choose what type of SIP they want to invest in based on the investment’s NAV.

Is systematic investment planning a good idea?

A SIP allows investors to invest in mutual funds in monthly or quarterly installments. It helps with averaging out investment costs and taking advantage of compounding. Therefore, it is a good idea.

Is a systematic investment plan (SIP) better than a fixed deposit (FD)?

SIPs come with investment diversification, flexibility, tax benefits, and a better return rate than FDs.

This has been a guide to Systematic Investment Plan (SIP) & its Meaning. Here we discuss systematic investment plan examples with advantages & disadvantages. You can learn more from the following articles – 

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