If the power of compounding is the eighth wonder of the world, patience and discipline are the architects of this wonder. Sure it may sound cheesy, but it’s true. And if we understand and truly harness the power of compounding, it can make all the difference in our financial journey.
Speaking of harnessing the power of compounding, one great avenue which does just that is a simple Systematic Investment Plan, or SIPs as they’re more commonly known.
What are SIPs?
Many of us are already aware of what SIPs are, but for those out of the loop, here’s a quick intro:
By definition, they’re a plan wherein investors make equal investments at regular intervals into a certain asset. More commonly, this investment is generally made into a mutual fund. For example, if Mrs. A invests INR 5,000 every month into XYZ Large Cap Fund, it can be considered as a SIP. They make use of the Dollar Cost Averaging principle.
In practice, mutual funds will typically have their own policies w.r.t. to the investment. For instance, the minimum amount, term, frequency of payments, etc. can all vary from MF to MF. But they can start from as little as INR 500/ month, with weekly investment plans also available.
Not only does this help investor stay disciplined by setting aside a fixed periodical investment ‘obligation’, but it also aims to avoid complications of timing the market. The idea here is to invest a set amount consistently which almost evens the playing field in terms of shorter-term market fluctuations.
The math using examples
Example 1
Looking at financial concepts on paper does injustice to the magic they can bring to one’s portfolio. So here’s a simple look at the numbers behind SIPs and why they’re such a hot topic among personal finance enthusiasts:
Let’s take a very simplistic example of two college friends, X and Y. They’re both 22 years of age and have recently got a job at a media company that pays them INR 30,000/mo. They both aim of retiring peacefully with a sizeable portfolio at retirement. Since they have different lifestyles, they decide to compare their portfolios after 25 years instead of deciding on an investment plan straight away.
X is very diligent with his investing and decides he is comfortable with investing INR 8,000 every month for the next 25 years using a SIP. He believes this amount strikes a good balance between saving & pleasure spending.
Y, on the other hand, considers himself a hedonist finds it very hard to save any money from his salary. Ultimately, he ends up splurging most of what he earns in the next 12 on the latest gadgets and parties. But once he realizes his mistake, he decides to double down on investing by putting in INR 20,000 every month using the same SIP for the next 13 years.
Here is what X’s and Y’s portfolios would look like after 25 years assuming they made no other investments.
While X was left with a corpus of over INR 76 lakhs, Y had less than INR 55 lakhs in his account. Which means that despite Y invested 2.5x more than X, his portfolio value is around 39% lesser than X’s.
Things get even more interesting when we take a slightly different approach – what if X were to invest for 13 years too, but instead started today? On the face of it, he is investing for as long as Y, but much earlier. Here’s the outcome:
Even though X invested INR 8,000 for 13 years, because he was early to invest, he could let his corpus compound for the remaining 12 years and was left with a little more than what Y had accumulated.
To take an even more interesting example, what if hypothetically X could invest INR 20,000 too but did so for the first 13 years like the previous example?
The numbers speak for themselves here. 2.5x the portfolio value for the exact same investment just timed better.
Example 2
Taking a different example, what if we assume something entirely different. SIPs are meant to be flexible. Let’s say that instead of your morning coffee at a cafe, you choose to invest that amount using a SIP for five years. This investment alone would be worth over INR 3.5 lakhs!
Do note that we understand there are shortcomings to this example. It is purely indicative in nature and is meant to show a simplistic idea of SIPs and how advantageous timing can be., ceteris paribus.
Pros & cons
How to go about starting a SIP?
Several well-known fund houses offer mutual funds with options to start SIPs, regardless of whether it’s a debt fund or equity or hybrid. Starting to invest using SIPs has literally never been easier thanks to advancements in the fin-tech space.
And while they’re popularly known as an easier way to invest in mutual funds, we must remember that one can reap the benefits of a SIP even without mutual funds:
We can also adopt a strategy where we invest a certain amount in a certain ETF, whether broad-market or sectoral. For instance, I could invest INR 5,000 per month in a Nifty ETF which would help me earn a return equivalent to the broad market.
To conclude
SIPs allow a wider demographic to make the most of the power of compounding. They truly can be a “chhote packet me bada dhamaka”. But it’s important to keep in mind that SIPs aren’t an investment, but rather a tool to invest. The underlying logic behind selecting a mutual fund or asset class remains the same. It’s just that SIPs offer a relatively easier way than putting in a larger lump-sum amount.
It’s also important to note that SIPs aren’t meant to replace any other investment avenue or tool. They’re simply a more convenient way of investing. For example, SIPs would be irrelevant for someone who has INR 30 lakhs to invest lump-sum. But they would be relevant if that same person wanted to invest a smaller amount every month.
If you’re curious about starting your investing journey or haven’t opted for SIPs yet, it could be a worthwhile option to consider. But please keep in mind that no one knows your risk appetite better than you. So please understand that none of what we discussed here is to be taken as financial advice or recommendation.
Happy investing!
This post was written in collaboration with Asif Yahiya Sukri LLP. Asif Yahiya Sukri LLP provides unparalleled personalized financial services to a broad range of clients across different geographical locations. With a presence in the USA, India and the MENA region, they ensure that all of your financial decisions are made carefully and with your best interests in mind. They are innovators who understand what goes into building companies.
You can also reach out to them at info@aysasia.com
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