What Is SIP?

One of the most popular ways to invest in mutual funds is through a systematic investment plan (SIP). In fact, many financial advisors consider it to be the best mode of investment. This is especially when it comes to tax-saving investment options.

Here is a handy guide that tells you all that you need to know about SIPs.

(Read more: What is a mutual fund?)

How Does SIP Work To Build Financial Discipline?

A SIP helps to integrate financial discipline into your investment habits. We are all aware of the importance of regular investments. But often, even if you have the best of intentions to invest at a steady pace you may forget to do so. When tax season comes by, you may end up making sizeable hurried investments. Still, you may find that these last-minute investments are insufficient. SIPs help you avoid such situations.

Some people invest according to the mood of the market. When there is optimism in the market, they rush to invest. And when the markets are down, they step on the brakes. When you have a SIP, investment occurs regardless of the prevailing mood.

What Are The Benefits Of SIP?

There are certain advantages to this form of investment over lump sum investment. Here are a few:

• Cost Averaging:

SIPs help you lower your average cost of investment. This principle is called rupee-cost averaging. Every month, the value of the mutual fund scheme undergoes changes. Units are thus available at a different price each month. When you invest a fixed amount every month regardless of market cycles, you buy varying amounts of mutual fund units. So, on the whole, the average cost of your investment falls.

• Power Of Compounding:

As you keep investing, you also earn returns on the returns that accumulate. The more you reinvest, the more you earn. So, the longer you invest, the higher will be your total return. This is why it is advisable to start investing as early as possible. You can also earn more profits through continuous reinvestment. This is how SIPs help you tap into the power of compounding. (Read more: How mutual funds work?)

• Timing:

The stock market is volatile in nature. Timing your investment to get the best price is not easy. With a SIP, you invest for a long period, irrespective of the market mood and volatility. This increases the probability of getting your timing right.

• Tax- Saving Schemes:

To save on tax, you can invest in equity-linked savings schemes (ELSS) or debt funds. Both these investments offer tax-saving benefits. Investing through SIP in ELSS qualifies you for tax exemptions under Section 80C of the Income Tax Act. (Read more: What is ELSS?)

To earn tax benefits on a debt fund, you have to invest for a minimum of three years. You will enjoy lower tax on long-term capital gains. (Read more: What is a debt fund?)

• Small Investors:

You do not need a huge amount of money to invest in a SIP. You can start a SIP with as little as Rs 500. It is one of the most affordable modes of investment available today.

• Flexibility:

It is best to hold SIPs on a long-term basis. But, you can stop the plan if you want to at any time. You may also increase or decrease your investment amount as well.

• Convenience:

You need to leave standing instructions with your bank to auto-debit the SIP amount every month. There is no need to run around submitting cheques or demand drafts.

• Disciplined Investing:

This is the key to wealth creation. When you are regular with your investments, you become disciplined with your savings. SIPs are a time-tested format of saving and investing. Even small amounts invested regularly can lead to significant gains.

• Waived-Off Fees:

A large number of asset management companies (AMCs) waive off entry or exit loads when investors invest through SIPs.

• Ideal For First-Time Investors:

SIPs are a boon if you lack sufficient knowledge to pursue active investment. It spares you from loss in volatile money markets. It also encourages the habit of disciplined investing.

• Lack Of Behavioural Biases:

When you invest through a SIP, your investment plans stay on track regardless of market fluctuations. If, however, you invest on your own, there is a danger of biases affecting your investments. You could end up altering your investment plans based on market conditions. In such cases, keeping the long-term view in mind can be hard to do.

(Read more: How to start a SIP investment?)