What is SIP and How does it work?

The most important lesson in the syllabus of personal finance is Investing. In Investing it is very important to know where to invest and how much to invest. But there is one more thing which is most important is to invest regularly.

So to keep investing regularly in certain securities the SIPs comes in handy. In this article, we will discuss everything about SIPs and what are the different types of securities in which you can invest through SIPs.

What is SIP?

The full form of SIP is Systematic Investments Plane as the name suggests SIP is a tool through which you can invest your money in certain securities systematically.

Generally, mutual funds offer the facility of SIP but now some startups are providing the facility of SIP in the different forms of investments like crypto. SIP allows the investor to invest a fixed amount of money at pre-defined intervals.

The pre-defined interval can be on a weekly, monthly, quarterly, semi-annual, or annual basis. The amount of the SIP can be as low as Rs. 500. SIPs are for the investors who are interested in long-term investment because SIP takes some time to show results.

How do SIPs works?

The SIPs work on the two principles i.e. Rupee cost averaging and compounding.

Rupee cost averaging:

We all know that the markets are so volatile and if you start investing by playing guessing games you gone lose all of your money. But if you start investing regularly for the long term through SIPs the average purchase cost evened out.

The logic is very simple you invest the fixed amount on the regular basis you will get fewer units if the market rises and you will get more units if the market fall. These reduce your risk and ensure that your average purchase cost remains low.

Compounding:-

Albert Einstein had said that compounding is the eighth wonder of the world. And you can use compounding to do wonders in your investment journey. When you invest a small amount every month then because of the effect of compounding you can see exponential growth in your returns.

You can understand the power of compounding through the following example. Let say you invest Rs. 1000 every month in a mutual fund that gives 12% returns for 20 years. 

Then at the end of tenure, you had invested Rs. 2,40,000 and your return will be around Rs. 7,59,148 it is nearly 7X returns.

Now I think you have a clear idea about SIPs and how they work, so now we will see which are the different types of SIPs.

Different types of SIPs:-

There are 7 different types of SIPs and there are as follows:-

1) Regular SIPs:-

This is the simplest type of SIP. Under this type of SIP, investors invest a fixed amount at regular intervals. The investor can invest daily, weekly, monthly, bi-monthly, quarterly, semi-annually, and annually through this plan. In this type of SIP, the investor cannot change the investment amount during the tenure. 

2) Top-Up SIP:-

It is also known as step-up SIP in this plan the investor is allowed to increase the investment amount periodically. When your income increase you can increase the investment amount as you want. Many asset management companies provide investors with Top-Up SIP plans.

3) Flexible SIP:-

As the name suggests the Flexible SIP allows the investors to invest flexibly. Sometimes it is also called Flexi SIP or Flex SIP. The investors are allowed to change the investment amount based on their financial condition. The investor has to inform the organization at least a week before the deduction date of the SIP.

Through this SIP you can invest more money when the markets are falling and invest less when the markets are high. You can even skip installments of your SIP without defaulting.

4) Perpetual SIP:-

In this type of SIP, the tenure of the SIP is not specified. The SIP will be continued till the investor provides instruction to the fund manager to stop the investment. This type of SIP allows you to stay invested for a longer duration and they can redeem their returns any time they want.

5) Trigger SIP:-

In this type of SIP, the investor is allowed to set up their SIP start date or redeem or switch their SIP when the selected event occurs. The investors can set up triggers for any event that occurs in Markets. This type of SIP only suites the investors who have in-depth knowledge about the market dynamics.

6) SIP with insurance:-

In this kind of SIP plan, you get the term insurance as an add-on feature. Initially, the cover of the insurance is ten times the first SIP amount and increases gradually with time. 

7) Multi SIP:-

The Multi SIP plans allow the investors to invest in multiple schemes through a single SIP. The Multi SIP plans help the investor to diversify his/her portfolio and reduce the risk.

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Which type of SIP is best to invest in?

The answer to this question is, it depends. It depends on your goals, income, and your knowledge about the markets. The regular SIP suite almost everyone who has a regular source and wants to save for a secured future.

If you want to achieve your financial goals faster and want to invest a large amount in a shorter duration then the Set-Up SIP is the best fit for you. You can go with Perpetual SIP if you are not sure about the tenure you want to invest your money for.

You should only select Trigger SIP if you have a good understanding of market dynamics. If you have a varying income then you should consider Flexible SIP to invest in. 

SIP with insurance is a new investment plan therefore you will hardly find any options available in markets. If you want to diversify your portfolio and reduce the risk then the Multi SIP is the best option for you. Before investing in the Multi SIP ensure that all the mutual funds of a fund house are performing well in their category.

Different types of mutual funds you can invest in through SIPs?

You can invest in almost every mutual fund through SIPs. Mutual funds are broadly classified into two categories they are as follows:-

Open-ended funds:-

Open-ended Mutual funds don’t have any maturity period. The investor can invest or exit at any point of time.

Closed-ended funds:-

Closed-ended funds have a maturity period. The investor can only invest in this type of mutual fund in the initial period known as New Fund Offer (NFO Period). The investor can redeem the investment on the maturity date.

The mutual funds are further classified based on the securities they invest in.

Types of mutual funds based on the securities they invest in:-

1) Equity mutual funds:-

This kind of Mutual funds allows the investor to participate in Stock Market without having much knowledge about Stock Market. These are some of the most popular Mutual funds. This type of mutual fund gives the maximum returns but also has a higher risk as compared to others.

Equity mutual funds are further classified into three different categories:-

Sector-specific funds:-

This type of mutual fund only invests in the stocks of a specific sector or a segment. The sector can be auto, infrastructure, insurance, etc or segments can be the small-cap, mid-cap, and large-cap. These funds are suitable for investors who want higher returns but at the same time ready to take higher returns.

Index funds:-

The index funds are for investors who want to invest in equity mutual funds but don’t want to depend on the fund manager. The index funds exactly follow the same strategy as the index it is based on. These funds are ideal for investors who want to take medium risks.

Tax saving funds:-

It is also known as the Equity Linked Saving Scheme(ELSS). This type of funds invest in equity and has a lock-in period of 3 years. The investments in these funds are eligible for the tax deduction.

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2) Money market funds or liquid funds:-

This type of fund gives reasonable returns over a short period. They invest in debt for a short period. These funds are suitable for investors with low-risk profiles and want to invest a large amount for the short term.

3) Fixed income or debt mutual funds:-

These funds invest the majority of the amount in debts like governments bonds and securities. The returns are low since the risk is low. These funds are for investors with low-risk profiles and want to generate steady income.

4) Balanced Funds:-

These funds invest in both equity as well as in debt. The percentage of investment keeps changing based on market risk. These funds are suitable for investors with a low-risk profile and want higher returns.

5) Hybrid/Monthly Income Plan(MIP):-

These funds are pretty much similar to the balanced funds but the percentage of equity investment is lesser as compared to balanced funds. These funds are ideal for investors who had retired and want to generate regular income with low risk.

6) Gilt Funds:-

These funds only invest in government securities. These funds are suitable for investors who don’t want to take any risk.

Conclusion:-

SIPs are a very important part of personal finance and everyone must have them. You can leverage the power of compounding in your investment journey through SIPs. In this article, we had discuss everything you should know about SIPs. 

We had discussed different types of SIPs and which suit you based on your goals. We had also discussed the different types of mutual funds you can invest in through SIPs. So figure out the right combination and start Your first Systematic investment plan today.

If you think I had missed out on something or you have any doubt about SIPs then feel free to comment below. And all the best for your investment journey.

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