Why do investors prefer SIP over lumpsum investment in mutual funds?

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Those who are able to manage their money wisely often succeed at investment planning. Saving and investing is essential for anyone who wishes to achieve financial freedom in near future. If you are earning a stagnant income and aren’t happy with it, you should start investing at least 40 percent of what you earn. The earlier you start saving the better it is. This way you will have more years in hand to achieve your monetary goals. Goal based investing never fails because as humans we are emotionally connected to our goals and generally do not stop mid way. Investing in market linked schemes like mutual funds can be a good idea for those who carry some risk appetite and seek long term capital appreciation.

Mutual funds are a pool of professionally managed funds that offer active risk management. These are market linked schemes that aim at generating capital appreciation over the long term by investing in a diversified portfolio of securities. Depending on the nature of the scheme and its investment objective, a mutual fund may invest across various asset classes like equity, debt, gold, real estate, etc. Apart from these, mutual fund schemes may also invest across various money market instruments like company fixed deposits, debentures, treasury bills, G-sec etc. Mutual fund investors are referred to as unit holders and are allotted units in quantum with the investment amount and depending on the fund’s existing NAV (net asset value).

What is SIP and lump sum investment?

Systematic Investment Plan is a method of investing in mutual funds. In SIP, one can invest a fixed amount at regular intervals till their investment objective is achieved. Investors need to decide an amount they are comfortable investing with after which every month on a fixed amount a predetermined amount is debited from the savings account and electronically transferred to the fund. Mutual fund investors are allotted units depending on their monthly SIP amount.

A lump sum investment on the other hand is the oldest method for investing in mutual funds. This way of investing is most suited for anyone who has surplus cash with them that is sitting idle. When investors make a lump sum investment, they invest the entire investment amount right at the beginning of the investment cycle. Since an investor is making lump sum investments, units are allotted in bulk to their mutual fund portfolio.

Why is SIP a better investment option than lump sum?

Those who start a SIP in mutual funds have several benefits compared to lump sum investment. To begin with, SIP investors tend to benefit from power of compounding. However, one needs to have a long term investment horizon if they need to make the most out of a powerful tool like compounding. In mutual funds, compounding refers to the interest earned on the interest earned from the principal investment amount. If investors continue to invest in mutual funds via SIP, over the long term their small SIP amounts can multiply and turn into a decent corpus. The interest earned from SIP is reinvested back in the scheme and if investors continue to invest in mutual funds via SIP for 7 to 10 years, they can benefit from the power of compounding. Another advantage SIP investments hold is that they also benefit from a tool like rupee cost averaging. This technique adjusts investment risk depending on market fluctuation. When the NAV of the fund is high lesser units are allotted and when the NAV of the fund is low more units are allotted.

If you seek capital appreciation over the long term by investing in mutual funds, SIP might be ideal for you. But investors are expected to consult a financial advisor before investing.