Why you should seriously consider a Step-Up SIP?

The traditional SIP assumes a constant amount invested in (say an equity fund) each month for a long period of time.

Apr 22, 2021 08:04 IST India Infoline News Service

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If you though that you are done and dusted by commencing your SIP or systematic investment plan, think again. Whether you are in a job or running your own business, the expectation is that your income will grow over time. After all, nobody works hard for their income levels to stagnate. In a growing economy like India, it has been generally observed that, barring exceptional circumstances, income levels tend to increase over a period of time. Now comes the problem with a traditional SIP.

The traditional SIP assumes a constant amount invested in (say an equity fund) each month for a long period of time. Now when your income levels and profits are going to increase over a period of time, there is no reason why your SIPs should not. Of course, you can start fresh SIPs, but there is a more automated way to do it. They are called Step-Up SIP, wherein the SIP is automatically enhanced on an annual basis.

Under-saving is as bad as not saving

There are two problems with the traditional constant SIP idea. Firstly, it is not linked to your income levels. That means, today you may be saving according to your potential but 5 years down the line you may be only saving 60% of your potential. The worst part is that you don’t even realize it as you remain smug in the thought that your SIP is doing its job to perfection.

Secondly, did you know that the same SIP can be used for multiple goals. We will look at this aspect in greater detail later but let us see what it means. Say, you have created SIP X to save Rs2cr for your retirement. Your normal tendency would be to start a new SIP for your daughter’s education, but for that you may prefer to wait for a few more years. In the process, you lose time value. A step-up SIP can start off with one goal, but actually address multiple goals.

How are step-up SIPs structured?

In a typical step-up SIP, the monthly SIP amount is automatically enhanced at the end of each year. For example, if your annual salary review happens in April, then you can coincide the step-up from May each year. This will ensure that even as your income levels increase, a part of it is automatically directed to your long term goals.

Broadly, there are 2 ways in which the SIPs can be stepped up.
  1. The first is a fixed-rupee step up. For example, you can start a SIP of Rs10,000 per month and then step up by Rs2,000 each year. So, over the next 5 years the monthly SIP contribution will increase to Rs12,000, Rs14,000, Rs16,000 and so on.
  2. Alternatively, you can also step up your SIP annually on fixed percentage basis. For example, you start a SIP of Rs10,000 per month and then step up by 10% each year. So, over next 5 years the monthly SIP contribution will be Rs11,000, Rs12,100, Rs13,310 etc.
Normally, mutual fund AMCs offer both these choices to step up the SIP but fixed accretions are preferred by most SIP investors. Now we come to the bigger question, does Step-Up SIP make a substantive difference to your corpus?

How much difference can step-up make to a SIP?

Let us simulate a SIP of Rs10,000 per month which is annually stepped up by 5%, 10% and 15% to understand the difference. We assume 14% yield on the equity fund over 25 years.
Scenarios SIP Amount Annual Step Up Yield / Tenure Total Invested Value of Investment
Scenario 1 Rs10,000 Nil 14% / 25 Years Rs0.30cr Rs2.72cr
Scenario 2 Rs10,000 5% 14% / 25 Years Rs0.57cr Rs3.38cr
Scenario 3 Rs10,000 10% 14% / 25 Years Rs1.18cr Rs5.26cr
Scenario 4 Rs10,000 15% 14% / 25 Years Rs2.55cr Rs8.87cr

One thing is very clear that even if you step up your monthly SIP amount by as low as 5% each year, your eventual corpus is almost 25% higher. In fact, if you step up the SIP by 10% each year, then the corpus doubles in 25 years compared to a flat SIP. You are able to achieve twice the original goal just by stepping up the SIP by just 10% annually. That is how powerful the step-up can be over longer periods of time and help meet multiple goals.

Why a SIP makes investment sense

Stepping up SIPs makes a substantive difference to the eventual corpus. Here is why step-up SIPs add value in multiple ways.
  • Step-up SIPs help the investors better synchronize SIP investments with a growing income profile.
  • Step-up SIPs inculcate automatic discipline of saving and investing more when you are earning more, which may otherwise be spent in unproductive avenues.
  • The step up is decided in such a way that you save and invest closer to your potential. That is the key to long term wealth creation, after all.

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