Systematic Investment Plan (SIP)

Definition

A Systematic Investment Plan (SIP) is a method of investing money in mutual funds, where an investor chooses to invest a specific, predetermined amount at regular time intervals, such as weekly, monthly or quarterly. It aids in inculcating the habit of saving and building wealth gradually. Also, it benefits from the power of compounding and the concept of rupee cost averaging.

Phonetic

Systematic Investment Plan (SIP) is phonetically pronounced as:Sis-teh-ma-tik In-vest-ment Plan (Ess Eye Pee)

Key Takeaways

1. Small but Regular Investments: SIP allows investors to start investing with a relatively small amount of money on a regular basis, making it a more manageable approach for those who cannot afford to invest a significant lump sum.
2. Power of Compounding: By continuously investing over a long period of time, investors can benefit greatly from compound interest that accumulates over time. This implies that every earning you get over your investment is reinvested and that earning, in turn, fetches more returns.
3. Rupee Cost Averaging: As you invest consistently over a period, you purchase more units when prices are low and less units when prices are high. This averages out the cost of investing and reduces the impact of market volatility on your portfolio.

Importance

A Systematic Investment Plan (SIP) is significant in the realms of business and finance due to it being an effective tool for individuals to invest in a disciplined manner. It provides a systematic approach to regularly invest small amounts of money into specific mutual fund schemes, instead of making a large, lump sum investment. Each payment buys a specific number of shares or units based on the current market price, enabling investors to benefit from the power of compounding and rupee cost averaging. Over the long term, this strategy can potentially lead to substantial returns, ensuring that the investor’s financial goals are met. This method also reduces the risk associated with market timing, making it an essential component of portfolio management.

Explanation

A Systematic Investment Plan, commonly referred to as an SIP, is a smart financial planning tool that assists individuals in creating wealth over a long-term period. The primary purpose of SIPs is to encourage regular investing, promoting a disciplined approach towards financial saving, reducing the burden of lump-sum investment, and mitigating financial market volatility. This is particularly handy for individuals who might find it challenging to save large sums at once but can afford to set aside smaller amounts periodically. SIPs are widely employed in mutual fund investment. They allow investors to buy units on a given date each month, so they can implement a saving plan for themselves. This usage aligns with the concept of ‘dollar cost averaging’ , where, no matter the market condition, regular investments are made. This long-term strategy can potentially lead to high returns as it mitigates the risks associated with market timing. Thus, the systematic investment plan is an ideal route for individuals seeking to accumulate wealth without drastic financial upset, while taking advantage of market fluctuations.

Examples

1. Retirement Savings: The most common real world example of a Systematic Investment Plan (SIP) would be a 401(k) in the United States or a similar type of retirement savings scheme in other countries. Employees specifically decide a fixed amount of their pre-tax salary to be deducted and invested into their retirement savings plan at regular intervals. The intention is to accumulate wealth over a long period with the benefit of compounding.2. Mutual Fund Investments: Some retail investors choose to invest in mutual funds regularly via SIPs. For example, an investor might decide to invest $100 monthly into a chosen mutual fund. This strategy is used to mitigate the risk of market timing, as the investment is distributed over a period, hence gaining exposure to different market conditions. 3. Education Savings Plan: Parents often set up SIPs to save for their child’s higher education costs. For instance, they might decide to invest a specific amount into a high interest savings account or a mutual fund regularly every month. By the time their child is ready for college, they would have built up a substantial amount of funds to cover the education expenses.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Equity Funds
• Compounding Returns
• Direct Plan
• Asset Allocation
• Diversification

Sources for More Information

• Investopedia
• Money Control
• The Economic Times
• Groww