Wednesday, February 2, 2011

Know About Your SIP

SIP : Systematic Investment Plan

Five things you ought to know about your SIP

1. Keep sufficient balance in your bank
To start an SIP in a mutual fund, you need to give an ECS mandate or post-dated cheques to the fund house. But that's not the end of it. You need to make sure you have sufficient  funds in your bank account on the date of investment. Funds houses are usually quite lenient in these maters and will overlook one or two instances of an SIP cheque bouncing. But if it happens three times in a row, your SIP will be canceled for good. To restart it, you will have to do the paperwork all over again.

2.Useful of certain asset classes
You can invest through SIPs in practically all asset classes-- equities, debt, gold and even real estate. After all, your home loan EMI is an SIP in real estate. But SIPs work best in volatile asset such as equities. That way you are able to average out your purchase price over the long term. You don't really need to take the SIP route when investing in the debt market where the fluctuations are minimal. Also, one can consider investing systematically in gold, which is another asset class with some volatility and is a good hedge against inflation.

3. Each SIP is an individual investment
Like each EMI of a loan, each installment of your SIP is a separate investment and treated individually while calculating tax and exit loads. If you started an SIP in a equity fund two years ago and withdraw the entire amount today, the SIPs that were made more than 12 months ago will not attract any tax. However the profits from the past 11 SIPs will be liable to 15% short-term capital gains tax because they have not yet completed a full year circle. So, even though you might have started the SIP sever months ago, each installment must complete a year to escape tax net. Also, these 11 installments would also be slapped with an exit load because they are being withdrawn before a year. This also holds true for ELSS funds, wherein each installment has a lock-in period of three years. So after three years of starting an SIP in an ELSS fund, you can withdraw units of only the first SIP. The next month, units of the second SIP become free from the lock-in and so on.

4. Monthly option is best
In the past few years, SIPs have evolved significantly. Apart from monthly and quarterly options, you now have the option to enter the market at fortnightly, weekly even daily intervals. However, a monthly option still works best because of the operational ease it provides. While daily and weekly SIPs even out the fluctuations well, they add to an investor's paper work. Also, out cash flows are monthly and we plan most things on a monthly basis, so it's easier to keep money aside at that interval. The quarterly mode takes too long. By the time the trigger date comes in you might have used all amount.

5. What's the right amount
Some mutual funds allow investors to put in as little as Rs.50 a month through SIPs. That may appear tempting but won't help in wealth creation. Even if your fund churns out good returns and you remain invested for the long term, the small size of the SIP means you won't accumulate a significant amount. Sure, the amount of investment is defined by the investible surplus that an individual has. But don't opt for a small SIP just because it is being offered by a mutual fund. Assess the size of your financial goal and then save accordingly.

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