Systematic Investment Plan (SIP) – Meaning, Types, Tax Benefits

What is a Systematic Investment Plan (SIP)?

A Systematic Investment Plan or a SIP is a form of financial savings where you regularly invest a fixed amount in financial assets.

It is a mode of investing in financial assets.

The underlying financial investment in which you are doing a Systematic Investment Plan can be shares, mutual funds, a recurring fixed deposit or even a pension plan under the Employees’ Pension Scheme.

The whole rationale of the Systematic Investment Plan is that the investments are being made at regular intervals with a fixed periodicity. You can invest in a SIP at your convenience – monthly, quarterly or half-yearly.

The whole purpose of doing a Systematic Investment Plan is to bring down your weighted average investment costs. This results in rupee cost averaging and increases your potential profit on your investment.

How is income elasticity of demand correlated to SIP investments?

Income elasticity of demand measures the changes in the actual income and the corresponding changes in the consumption of various goods and services.

In the goods we consume, savings and consequent demand for financial products are also included.

Income elasticity of demand = Change in the consumption of goods and services / Changes in the consumer’s real income.

If this ratio is greater than 1, it signifies that you have a higher income elasticity of demand; if it is below one, you have a low-income elasticity of demand.

In this case, real income means the total income you receive from all sources deflated for the inflation rate in the economy.

The changes in the CPI Index measure the inflation rate.

So, if your income increases by 10%, but you increase your allocation to the savings bucket by 15%, you have a high-income elasticity of greater than 1 for your savings component and, consequently, your income elasticity for doing SIPs.

Your allocation to savings is discretionary, so you are income elastic when it comes to savings and SIP investment planning.

Income elasticity plays a critical role in determining the allocation of resources in your household budget. It also helps categorise your various buckets of expense in a profit maximising manner. All things being equal, the potential for the allocation to the savings bucket to increase with your income increase has a high probability.

How does a SIP work?

A SIP investment Plan works on the following premises:

• Wealth accumulation happens over a long period due to the power of compounding.
• You can maximise the potential profit on your investment by investing small amounts in a share or a mutual fund due to the following: Markets move in cycles with both uptrends and downtrends. If you invest in both up markets and down markets by doing SIP investment planning, you can bring down the weighted average costs of your SIP investment.
• No one can accurately time the market. You can never succeed in buying at the lowest point of the market or selling at the highest point. So a SIP investment plan is the best method to achieve the lowest possible acquisition costs.
• With a lower weighted average cost of the SIP investment, you are in a position to increase your overall potential profits from your financial investments.
• When you commit to making a SIP investment in a mutual fund, you automatically pledge to keep aside a portion of your savings for investment in a particular financial product over extended periods. In other words, you create a bucket in savings that are earmarked for a SIP investment in a mutual fund, and you do not expend it for any other purpose. You bring financial discipline to your investment process by committing to a SIP investment plan in a mutual fund.
• Most online fintech platforms and online and offline brokers offer SIP investment plans in their boutique of products.
• When you invest through a SIP investment plan in equity mutual funds, during bearish markets, which occurred during the Ukraine Russian war period, the price or the Net Asset Value of the mutual Fund will come down, so you can buy more units of the mutual fund. Similarly, when the markets are surging high (during the festival season, year-end and pre-budget), mutual fund Net Asset Values will also be higher. So your fixed Systematic Investment Plan will buy a lower number of units. The purchase NAVs of the mutual fund units under your SIP will average out, and weighted average costs will be proportionately lower.
• When you do a systematic investment plan in a fixed income or a bond mutual fund, the bond mutual fund Net Asset Values are generally lower when the market interest rates are higher and lower when the market interest rates are higher. Bond prices are inversely related to interest rates. So when you are doing a Bond Mutual fund SIP, you will buy lower units when the market interest is low (for example, during the Covid-19 period). As market interest rates trend high, you will be able to buy a higher number of bond fund units as the bond fund Net Asset Values fall.
• While investing in a SIP investment plan, you automatically buy lower units when the mutual fund’s Net Asset Values are high and a lower number of units when the mutual fund’s Net Asset Values are higher. This also satisfies the investment principle of “Buying low and Selling High”.

Types of SIP

• Perpetual SIP: as the name indicates, this type of SIP Mutual Fund investment means that you continue to do the SIP for an infinite period without naming a final date. When you fill-up a mutual fund form for the SIP investment plan, you can also indicate when you want the SIP in the mutual fund to end. This would be a goal-based form of investing. Otherwise, you can also end a perpetual SIP if you need to meet specific urgent financial needs.
• Top-up SIP: In a top-up SIP investment plan, you can add additional amounts to your SIP investment plan in a mutual fund when your income increases or you receive a gift or a windfall income. This can be in the form of a lump sum added to your regular SIP investment plan. This will help you achieve your financial goal faster, especially when the mutual fund performance warrants such an increase.
• Flexible SIP: In this type of SIP investment plan, you can increase or decrease the SIP amount you invest in a particular mutual fund. You may do this when you have varying personal financial expenditures, as your contributions to the mutual fund SIP are also variable. In some instances, this type of SIP investment plan allows you to skip some instalments if you face a severe financial crunch.
• Trigger SIP: This is a kind of systematic Investment Plan used by market experts who are very conversant with market volatility and other market indicators. They can judge the breakouts in the market and plan to increase their SIPs in mutual funds in line with such breakouts. It is almost akin to timing the market and is generally not advised for passive investors. You can also make a wrong judgement call, and this form of SIP can turn into a losing proposition.

Why should you invest in mutual fund SIPs?

Most of us juggle between busy professional careers and personal lives. We also desire a secondary source of income from your financial savings. We also seek to achieve a work-life balance and spend quality time with our family.

A SIP investment Plan in mutual funds is the best option to attain all these three goals. You can safely plan a SIP investment in your selected mutual funds. This allows a hands-free approach, where you do not have to time the market, determine points of entry, or analyse market trends.

You can safely be a passive investor and allow your fund manager and the selected SIP investment plans in mutual funds to work for you.

Frequent monitoring is required, but you are not engaged all the time in monitoring the NAVs of your mutual funds and determining the appropriate point of entry. This will help you achieve your financial objective of wealth maximisation with a diversified portfolio of mutual fund assets while you focus on your primary career.

SIP investment plans in mutual funds also help you reduce your weighted average cost of investment which increases your potential long term profit.

As you invest for the medium to long term, compounding helps to maximise your wealth accumulation. You also cannot be driven by sentiment or emotion due to the market vagaries.

Who should invest through a Systematic Investment Plan?

Anyone who is an adult from any walk of life and of any age can start a SIP plan of investment in mutual funds. Someone who is a minor can also invest in a SIP with the help of his parents or a guardian.

You don’t need a great deal of market knowledge and expertise to start a SIP Plan of investment in mutual funds. You also don’t need to devote your time and attention to purchasing and monitoring your SIP investment in mutual funds. Your only responsibility is to ensure sufficient funds in your bank account from the SIP amount to purchase mutual funds are deducted regularly.

Benefits of investing in a SIP

• SIPs help you achieve long-term wealth maximisation to meet your financial goals.
• SIP investment plans help you achieve your portfolio diversification and risk minimisation objectives. SIP investment plans in mutual funds are available in all asset classes. You choose equity, bond, commodity, liquid, foreign equity mutual funds, or balanced mutual funds with an underlying combination of equity and debt. You can have mutual funds diversified by industry segment or sector. The third form of diversification is by the fund manager. You can pick mutual funds run by different managers, the best performing managers in each asset class while doing your SIP.
• You can invest passively without worrying about timing the market.
• You can bring down the weighted average cost of your portfolio investments.
• You do not have to devote a large portion of your time and effort to monitoring and purchasing your SIPs.

How to start a SIP investment? 

1. Completion of the appropriate due diligence

Determine your financial goals

Analyse your risk-return profile

Select the different buckets you want to invest your money in, like equities, bonds, real estate, and liquidity.

Analyse the best fund from the fund’s past performance, manager ranking, and the fund’s risk profile.

Plan your savings available to invest and your plans to bifurcate it into the various buckets for SIP investment plans in different mutual funds; you can start the process.

2. Select and approach an online fintech platform or an online provider of mutual funds
3. Fill out an application form online to open an account to start a systematic investment plan in mutual funds.
4. Complete all KYC requirements with documentation proof like identify proof, address proof, a Cancelled cheque from the bank from which the SIP Payments would be deducted, and 2 photos. Please note that providing PAN Card and Aadhaar Card copies is mandatory.
5. Finalise the mutual funds you want to do a SIP investment Plan
6. Decide the frequency of your SIPs; Monthly or quarterly, or half-yearly.
7. Fill up online applications for the respective mutual funds to start your SIP.

How to choose the Best SIP Plan to invest with?

The SIP plan must meet your portfolio diversification, maximise return, and minimise risk objectives. It would help if you first analysed the following parameters:

1. Historical Performance of the Fund returns: In the case of an equity fund, the recent return performance and performance over three years and five years must be analysed. In the case of bond funds, you have to look at the post-tax yields that the bond fund is offering before making your determination. It would help if you also looked at the dividend history of the fund.
2. The risk or the volatility of the Fund: The fund’s risk or volatility is also to be analysed. Ratios such as Sharpe ratios and Treynor ratios are available, which analyse the mutual fund’s risk. Sharpe ratio measures the risk-free rate of return (Fund return- market interest rate) / standard deviation of returns. Treynor ratio measures the risk-free return against the covariance of the mutual fund return with market index return. The higher the Sharpe or the Treynor ratio, the better the fund performance.
3. Analyse the mutual fund Expense ratio: Mutual funds have different charges like Asset Management fees, fund administration fees, brokerages and other trading costs. The expense ratio is the total of all these costs / Total amounts of the Assets under Management. The lower the expense ratio, the better your investment performance.
4. Analyse the entry or exit load of the mutual fund. These are the commission charges you pay either at the time of entering the fund or at the time of the exit.
5. Analyse the type of the fund: whether the fund is open-ended, which means you can enter or exit at any time. A closed-ended fund typically allows only lump sum investments with staggered exits when the investments are redeemed.
6. Check the track record of the fund and the manager: You have to check whether the fund has been in existence for more than five years. The fund manager and the fund house should have a consistent track record of performance and consistent ranking.
7. The corpus of the fund is sizable, at least over Rs. 500 crores. This would help you to avoid problems due to low liquidity.
8. Under equity, mutual funds seek ELSS tax saver funds to facilitate tax planning. In bond and fixed-income funds, look for good CRISIL ratings to vouch for the creditworthiness of the underlying bond investments.

Systematic Investment Plan Tax Benefits:

The only tax benefit you can avail of is investing in a SIP in ELSS tax Saver mutual Funds. Under the old income tax regime, you can avail of deductions of up to Rs. 150,000 under the old regime of taxation. Otherwise, you are taxed according to your tax slab.

Under equity mutual fund investment SIPS, both your dividend and capital gains are subject to tax. In bond funds, you can increase the cost of bond funds by indexing it to the growth in the CPI Index before calculating capital gains tax. Interest income is taxed according to your taxation rates.

Factors to consider before investing in SIPs

The factors to be considered while doing a mutual fund SIP include:

1. The Investment Objective of the Fund: where the fund plans to allocate its invested amounts, geographical allocation, sectoral allocation, top ten holdings etc.
2. Type of Fund: whether open-ended or close-ended, type of asset class
3. Historical return and risk performance
4. Fund house or fund manager ranking
5. Expense ratios and entry and exit loads.

SIPs v/s Lump sum investments

SIPs bring down your weighted average cost of investments. You do not need a large corpus to invest in SIP investment plans. You don’t have to time the market and determine an appropriate entry point as you stagger your investments.

In lump sum investments, market timing is critical. It would help if you had a large fund corpus. As you cannot always determine the market trend, you may enter your investment when the Fund NAVs are relatively high. This reduces the profit potential and does not satisfy your wealth maximisation objective.

Key Takeaways

SIP investment plans are the best mode of investment when you are investing for the medium to long term. You can successfully juggle your primary professional career and work-life balance and create a secondary source of income by doing a SIP investment plan into mutual funds. 

SIP Plans can be diversified to meet your portfolio diversification objectives, keeping your risk-return tolerance in perspective. It satisfies your long term profit and wealth maximisation objectives and meets your financial goals easily. SIP investment plans make you a disciplined investor who carefully plans your investments. Do not delay; start your SIP account and invest in your best SIPs today.

Frequently Asked Questions (FAQs)

Why should I choose a SIP investment Plan?

SIPs offer a cost-effective and straightforward solution to financial planning without much active involvement and monitoring by you.

Is there a best time to start a SIP?

There is no best time to start a SIP. You can start a SIP investment plan as soon as you have a regular savings plan set up.

How much money do I need to start a SIP?

Many mutual fund houses offer SIP starting at Rs. 500. You can always top-up or vary your SIP amount as and when required.

Can I miss a SIP payment?

When you face financial difficulties or a cash crunch, you can miss a few SIP payments without your SIP Plan closed.

Do all SIPs have tax savings effects?

No, only Equity Linked Savings Schemes SIPs enjoy the benefit of a Rs 1,50,000 p.a deduction from your total taxable amount under Sec 80 Cc under the old Income Tax regime.

Are all SIPs safe?

SIPs are only a method of investing. The underlying investments still are exposed to the risks of that particular asset class. Equity investments are subject to market risk. Debt or bond funds are subject to interest rate risk.

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