What is a mutual fund?
The first question you are probably likely to ask as a beginner is what are mutual funds? Mutual funds are instruments for investment. They pool in money from various investors and invest in a variety of securities. These include, stocks, bonds, government securities and money market instruments. Mutual funds can be broadly divided into the following categories:
• Equity funds- These funds invest in equities or stocks
• Debt funds- These invest in debt related instruments such as bonds issued by corporates and financial institutions and Government securities
• Hybrid funds- These are funds that invest in both equities and debt in varying proportions, depending upon its objective
Each of these categories have various types of schemes that carry different degrees of risks. Mutual fund risks emanate from the fact that they invest in market-related instruments. The key to successful investing in mutual funds lies in matching the investment objective of the fund to your own risk and return appetite.
What is a SIP?
Now that you know all about mutual funds, it is time to tell you what is SIP. A SIP, unlike a mutual fund, is not an instrument in itself. It is a process or an investment method through which you can contribute in mutual fund schemes in small amounts regularly. A specified amount of money is auto debited from your account towards investment in a mutual fund scheme on a monthly or quarterly basis (depending on your preference).
You can begin a SIP with an amount as low as Rs500. You also have the option of increasing this amount as your salary or income goes up through a top up facility that SIPs provide. Mutual funds provide the facility of topping up your SIP by 10% annually.
Advantages of SIP
SIPs are recommended to retail investors, because they build financial discipline and are effective in meeting long term goals. SIPs provide the advantage of rupee cost averaging. This means, SIPs work in a mechanism in which you buy lesser units when markets are high. Conversely, you buy a higher number of units when markets are low. As a result, your costs are averaged out. This also provides protection against market volatility.
SIPs also provide the advantage of compounding. This means, the returns from your investment are re-invested into the fund. The longer you remain invested in a SIP, the more you stand to gain. Thus, if you tie a SIP to a long-term goal such as building a retirement corpus or saving for the higher education of your children, SIPs can prove to be beneficial.
However, you need not restrict investment in SIPs to long-term goals alone. You can begin different SIPs in different mutual fund schemes, depending upon your risk appetite, financial goals and time horizon for the goal.