Investing can be a complex world, especially with the enormous options available. Two popular investment terms you have encountered are SIP and mutual funds. While they are related, they are not the same thing. This blog covers the differences between SIP and mutual funds, how they work, their advantages and disadvantages, and what to consider before choosing between them.
What is SIP?
SIP stands for Systematic Investment Plan. It is a method of investing a pre-defined amount in mutual funds at regular intervals, usually monthly or quarterly. SIPs are designed to instil a disciplined savings habit among investors. By investing systematically over time, you can average the cost of your investments, mitigating the impact of market volatility. This method allows investors to build wealth gradually and can be especially beneficial for those new to investing.
What is a Mutual Fund?
A mutual fund is a type of investment in which an authorised fund house (such as banks and AMC) pools the money from investors and trades in various securities and bonds on behalf of the investor. This diversification helps spread risk, as the fund’s performance is not reliant on a single investment. Mutual funds come in various types, including equity, debt, balanced funds, and more, catering to different risk appetites and investment goals.
Difference Between SIP and Mutual Fund
While SIP and mutual funds are closely related, they are different. The table below points out the differences between SIP and mutual funds:
| Aspect | SIP (Systematic Investment Plan) | Mutual Fund |
| Definition | An approach to investing in mutual funds through consistent, modest contributions. | An investment instrument that combines funds from numerous investors to acquire securities. |
| Investment Approach | Regular, fixed contributions (e.g., monthly, quarterly). | It can be a lump-sum investment or through SIPs. |
| Flexibility | Provides versatility regarding the size and frequency of investments. | Investors can choose lump-sum or SIP at their convenience. |
| Risk Mitigation | It helps in averaging out market volatility through rupee cost averaging. | Risk level depends on the type of mutual fund (equity, debt, hybrid, etc.). |
| Minimum Investment Amount | Generally low (e.g., ₹500 or ₹1,000 per month). | Varies: lump-sum investments typically require a higher minimum amount. |
| Investment Horizon | Typically encourages long-term investments. | Depending on the fund type, it can be short-term, medium-term, or long-term. |
| Market Timing | Reduces the need for market timing as investments are spread over time. | Lump-sum investments require careful consideration of market timing. |
| Convenience | Highly convenient for disciplined, regular savings. | Lump-sum requires a substantial amount; SIP offers convenience for regular savers. |
| Returns | The potential for averaging returns over time depends on the market. | Returns depend on the performance of the fund’s underlying assets. |
| Liquidity | Generally provides good liquidity; can stop SIP anytime. | High liquidity; mutual funds can be redeemed anytime (except for specific lock-in periods like ELSS). |
| Cost Averaging | Yes, due to regular investments, it averages out the cost of purchase. | There is no inherent cost averaging unless invested through SIP. |
| Discipline | Promotes disciplined investing habits. | Discipline depends on the investor’s approach (lump-sum vs. SIP). |
| Suitability | Suitable for new investors and those with regular income. | Suitable for different types of investors, from conservative to aggressive. |
SIP in Mutual Funds – How They Work?
SIP in mutual funds allows one to invest a predetermined amount regularly. Here’s how it works:
Selection of Mutual Fund: Choose a mutual fund that goes with your financial goals and risk tolerance.
Decide on SIP Amount and Frequency: Determine the amount you wish to invest regularly and the frequency (monthly, quarterly, etc.).
Automatic Investments: The specified amount is automatically debited from your bank account and invested in the chosen mutual fund.
Units Allocation: The investor is allocated units based on the fund’s prevailing NAV (Net Asset Value). With each SIP instalment, more units are purchased.
Wealth Accumulation: Over time, these investments grow, and the power of compounding can help build significant wealth.
Advantages of Investing in Mutual Funds and SIP
Advantages of Mutual Funds:
Diversification: Spreads risk across various investments.
Professional Management: Managed by experienced fund managers.
Liquidity: Easy to buy and sell.
Variety: Various types to suit different investment goals.
Advantages of SIP:
Disciplined Investing: Encourages regular saving.
Cost Averaging: Mitigates market volatility impact.
Flexibility: You can start with small amounts.
Compounding: Benefits from long-term compounding.
Disadvantages of Investing in Mutual Funds and SIP
Disadvantages of Mutual Funds:
Fees and Expenses: Management and administrative fees can reduce returns.
Market Risk: Subject to market fluctuations.
Lock-in Period: Some funds have lock-in periods.
Disadvantages of SIP:
Regular Commitment: This requires regular investment, which might be difficult during financial constraints.
No Control Over Market Timing: Automated investments may not always capitalise on market conditions.
Considerations When Deciding Between SIPs and Mutual Funds
Investment Goals: Determine your financial objectives and choose accordingly.
Risk Tolerance: Assess your tolerance for risk before making investments.
Time Horizon: Longer investment horizons can benefit more from SIP.
Market Conditions: SIP can improve in volatile markets due to cost averaging.
Financial Discipline: SIP encourages regular investing, which can benefit undisciplined savers.
Conclusion
Deciding between SIPs and mutual funds depends on what you want to achieve with your money, how much risk you’re comfortable with, and how you plan to invest. SIPs help you save regularly and even in market ups and downs, making them suitable for steady savings. Mutual funds spread your money across different investments, managed by professionals, offering options for various investment goals. Each has pros and cons, so understanding these differences is critical to making intelligent choices. Getting advice from a financial advisor can clarify things. Start early, stick to your plan, and you’ll benefit from steadily growing your money over time.
FAQs
Ans: Yes, you can stop your SIP anytime without any penalties. However, consulting with your financial advisor before making such decisions is advisable.
Ans: Missing a SIP instalment will not attract any penalties, but it’s essential to maintain regularity to achieve your financial goals.
Ans: You can invest a lump sum and start a SIP in the same mutual fund to take advantage of both investment strategies.
Ans: SIP returns are not guaranteed as they are subject to market risks. However, SIP can help mitigate some risks through cost averaging.
Ans: The NAV of a mutual fund is calculated by dividing the total value of all assets in the fund’s portfolio by the number of outstanding units.
Ans: An SIP has no mandatory minimum duration. However, continuing for at least 3-5 years is advisable to benefit from the potential of compounding and rupee cost averaging.
Ans: Some mutual funds offer the option to pause your SIP for a certain period and resume it later. Check with your fund house for specific details.
