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What are SIPs and how it helps in wealth creation

Mutual Funds

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Over the past twenty years or so, mutual fund systematic investment plans have gained tremendous popularity and have one of the most favored investment choices for retail investors in India. There are a number of advantages in the SIP mode of investing:-

  • The biggest advantage SIP is enabling disciplined investing from your regular monthly savings. You do not have to wait to accumulate a large savings corpus to start investing in mutual funds. You can start with a SIP of just Rs 1,000. Investing small amounts systematically over long periods of time can create substantial wealth for investors through the power of compounding. We will discuss power of compounding in more details later in this post.

  • The second major advantage of SIP is the convenience. Through a one-time bank ECS mandate, a fixed sum will get debited from your bank account every month (or any other period e.g. weekly, quarterly etc) and get invested in a mutual fund scheme(s) of your choice. You can select the date of auto-debit from the bank, frequency, amount (subject to minimum amount specified by the Asset Management Company) as per your convenience. You can stop your SIP and increase / decrease the SIP amount at any time. There are no penalties for missed SIP payments. By investing through SIP, you can put your financial planning on auto-pilot mode.

  • The other big advantage of SIP is that, it makes market timing irrelevant. It is not possible to predict accurately how markets will behave. By investing at a regular frequency, investors can take advantage of volatility through Rupee Cost Averaging. Investing through SIPs during volatile market periods, market corrections and even bear markets, investors can get very high returns in the long term.

  • Equity and equity oriented hybrid mutual fund schemes are among the most tax efficient investment options in India. Capital gains or profits of up to Rs 1 Lakh from mutual funds schemes held for more than 1 year are tax exempt. Profits in excess of Rs 1 Lakh are taxed at 10%.

Wealth creation through SIP – Compounding

We will now discuss how SIPs create wealth through the power of compounding. What is compounding? Compounding is essentially, interest earned on interest or profit earned on profit. If you invest Rs 1 Lakh at 10% interest, then after 1 year you will receive interest payment of Rs 10,000. However, if you let the money remain invested for 5 years, then your interest will not be Rs 50,000; your interest will be more than Rs 61,000. When you remain invested for a long time, it is not just your investment (principal) which earns interest or returns. Your accrued interest or your accumulated profits also earn interest or returns. This is how compounding works.

Time – the key factor in compounding

Time is the most important factor in compounding. The longer you remain, more profits you can accumulate, which is in turn help you earn even more profits. This is a virtuous cycle and creates enormous power of compounding. We often get queries from investors asking which funds will give the highest returns. But the more important question, investors should ask themselves is how they can remain invested for the longest period of time because time is more important than getting incrementally higher relative returns. For example, if you invest Rs 1 Lakh in a scheme which gives 20% annual returns for 3 years, your investment will grow to Rs 1.7 Lakhs. On the other hand, if you can remain invested for 15 years, your money will grow to Rs 4.2 Lakhs, at just 10% annualized returns. You can see that, even though your annualized return was much lower in the second case, you were able to create much more wealth by simply remaining invested for a long period of time.

SIP leverages the power of compounding

With SIP, you start investing early with small amounts from your regular savings and therefore, can remain invested for very long periods of time. This enables mutual fund SIP to leverage the full power of compounding. The table below shows a scenario analysis of the corpus built over various periods of time at different investment return rates, with a monthly SIP amount of Rs. 5000/-


Mutual Funds - SIP leverages the power of compounding


You can see that over long investment tenures (20 to 30 years), you can create substantial wealth with relatively modest investments. In our view, SIP is the best investment option for your long term goals like children’s higher education, children’s marriage and your retirement planning.

Example of wealth creation through SIP

The chart below shows returns of Rs 5,000 monthly SIP in Indiabulls Bluechip Fund since inception (February 2012). You can see that investors made cumulative profits of more than Rs 2 Lakhs during the past 7 years, by investing through SIP.


Mutual Funds - Wealth creation through SIP

Source: Advisorkhoj SIP calculator


About Indiabulls Bluechip Fund

Indiabulls Bluechip Fund was launched in February 2012 and has Rs 278 Crores of Assets under Management (AUM). The expense ratio of the scheme is 2.51%. The minimum SIP amount in this scheme is Rs 500 only. Exit load in this scheme is 1% for redemptions within 365 days from the investment date. For redemptions after 365 days from investment date, no exit load is charged. As per SEBI’s mutual fund classification, Indiabulls Bluechip Fund is a large cap equity fund. The scheme benchmark is BSE Sensex 50 TRI. Large cap equity funds are less volatile than midcap or small cap equity funds and are therefore, more suitable for new investors or investors who do not have high risk appetites – the risk profile of this scheme is moderately high. The fund manager of this scheme is Mr. Veekesh Gandhi. The scheme gave around 11% annualized returns since inception and 15.7% annualized returns in the last 3 years, outperforming the category average.

Conclusion

In this post, we saw that by investing a portion of your regular savings in mutual funds in a disciplined way through SIP, you can accumulate a large corpus over a sufficiently long investment horizon. This is due to the power of compounding. During a market downturn, the investment value may temporarily decline a bit, but at the same time, through SIP you will be investing at lower prices which will get you superior returns in the future. Through SIPs investors can create a win-win situation for them over long investment tenures. Investors should discuss how to invest for their long term financial goals through mutual fund SIPs with their financial advisors.

Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.

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Advisorkhoj Research Team

Our research team has a combined experience of nearly 40 years in the financial services management and distribution, across the entire spectrum of product classes including mutual funds, insurance, equity broking and loan products. To contact our research leads, please see their contact information below.

Dwaipayan Bose: dwaipayan@advisorkhoj.com
Pradip Chakrabarty: pradip@advisorkhoj.com

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