While saving money is important, investing wisely is even more crucial, as it allows you to maximise your wealth over time.
Investing as early as you can is ideal so that you can save adequately for major expenses later on in life and post-retirement. One smart way of investing is through Systematic Investment Planning, more often referred to as investing in SIPs or Systematic Investment Plans.
As per the Association of Mutual Funds of India, data indicates that SIPs are a sought-after option for most mutual fund investors. Over 9 lakh SIP accounts were created on average in each month in FY 2017-18.
What are SIPs?
As the name suggests, a SIP involves investing a fixed sum of money at regular intervals (usually monthly, though you could invest quarterly too). Then, a money market expert takes this money and buys units of a scheme, usually a mutual fund, at a pre-determined frequency.
SIPs allow you to invest in securities safely and securely. You don’t have to worry about selecting the right securities as your financial advisor will do so on your behalf. Also, since you can invest flexibly, this option is suited to all kinds of investors. It doesn’t matter if you’re an experienced investor or are investing for the first time.
How are SIPs calculated?
SIPs are calculated by taking into account two principles: the power of compounding and rupee cost averaging. Take a look at how these mechanisms work.
Power of compounding
This means that the interest you earn is compounded as opposed to simple interest. For example, if you invest Rs. 5,000 at 10% for 5-years, the interest will be Rs. 2,500. So, your total gain will be Rs. 7,500.
On the other hand, when interest is compounded on Rs. 5,000, your total interest earnings will be Rs. 3,052.55. In turn, your total gain will be Rs. 8,052.55. Here, in the first year, you earn Rs. 500 as interest. This is compounded, which means that it is added to your principal. As a result, the principal for the second year is Rs. 5,500. This method allows the interest to earn returns, too, thereby enriching your benefits.
The difference between the two may seem nominal, but the benefit of compounding is staggering when you invest in a SIP for an extended period. For instance, when you invest for 20 years or more, the total amount is more than double what you would earn if you were to receive simple interest on it.