Difference Between SIP and Mutual Fund

Let’s understand the key differences between mutual fund and SIP in the following table:

Mutual funds are a popular investment option these days as they can potentially help investors diversify their holding across multiple stocks, bonds and even asset classes with ease. Mutual fund investments pool the money of multiple investors and a designated fund manager invests this pool of money in different assets based on the specified fund objective. The diversification in a mutual fund portfolio helps control overall investment risk. Mutual fund offerings cater to diverse investment targets that match investor’s financial goals as well as risk appetite.

Systematic Investment Plan (SIP) is a disciplined way to invest relatively small amounts of money regularly (daily, weekly, monthly, etc.) in mutual funds. In the case of SIP, you have to invest a specified amount of money at chosen intervals in the fund of your choice. Since the investment amount remains unchanged, the investor purchases fewer units when the fund NAV is high and more units are accumulated when the fund NAV is lower. This helps reduce the effect of market fluctuations and allows you to average out the price of purchasing units. This way you can add little bit of money every month to your investments, which adds up over time.

Below are some of the key benefits of investing in mutual funds:

• Your investment spreads across multiple assets, resulting in risk reduction.
• Fund managers with in-depth make investment decisions assisted by a team of analysts which can lead to potentially better returns compared to investing by yourself.
• Mutual fund units offer high level of liquidity as they can be easily bought and sold through various channels.
• There are various types of funds that can serve diverse financial objectives for investors with varying risk appetites.
• These funds grant individuals access to different asset types, including stocks, bonds, gold, silver, real estate, etc. which may not be available through other investment instruments.

Below are the key benefits that have contributed to the popularity of systematic investment plans:

• Rupee Cost Averaging method allows you to purchase more units during market downturns and fewer units during market bull-runs, reducing the impact of market volatility on your investments.
• A disciplined investment process is achieved through automated contributions, which help you develop better financial habits.
• You can begin investment through SIP with relatively small amounts so that your household budget is minimally impacted.
• SIP can help investors stay invested over the long-term with regular contributions providing an opportunity to harness the power of compounding.

The following are some common misconceptions that exist with respect to SIP and Mutual Funds:

• SIPs guarantee high returns: This is not correct. SIPs provide the benefit of rupee cost averaging that can help manage market volatility to some extent, but SIPs do not offer guaranteed returns.
• Only wealthy individuals can participate in mutual fund investments: This is not true. You can begin investing in mutual funds with very small amounts such as Rs. 100 per month in many cases.
• SIPs are a financial instrument like mutual funds: This is not the case. SIP is just one of the many way in which you can invest in mutual funds.
• Past performance can be used to future returns: This is not the case. Historical performances can be used as predictor of future returns due to the inherent uncertainty of markets.

Investors opting for SIPs in equity funds or balanced mutual funds incur capital gains tax. Fund type and holding period determine the tax rate for mutual funds. Equity fund investments lasting longer than one year are eligible for long-term capital gains tax (LTCG) of 12.5% applicable on equity gains exceeding Rs. 1.25 lakh in a financial year. This is lower than short-term capital gain tax (STCG) of 20% on gains from equity mutual fund investments held for less than 1 year. It means that if you sell your equity funds after a year or more, you pay lower taxes. However, if you sell sooner, the tax payment will be higher.

It is noteworthy that debt funds have separate tax regulations so both long and short-term capital gains in the case of these investments are taxed as per income tax slab rate of the investor. It is important to note that tax rules are applicable based on the type of fund one is redeeming and the holding period irrespective of whether the investment was made via SIP or lump sum.

Starting investments with SIPs and mutual funds requires less effort than most people assume. The initial requirement to start investing in mutual funds is to complete KYC (Know Your Customer) requirements. You must start by picking a reliable Asset Management Company (AMC), after which you should select a mutual fund that matches your investment goals, investment tenure and risk appetite. Additionally, when starting a SIP you will also need to determine your investment period, individual installment amount, and SIP frequency.

Returns from systematic investment plans tend to differ considerably depending on the mutual fund category one has invested in. Equity funds have historically provided higher returns in the long term but are prone to high volatility especially in the short term. Debt funds typically feature lower lower volatility as they primarily invest in fixed-income securities such as bonds, certificate of deposits, etc.

However, the returns of debt funds tend to be lower than that of equity fund especially in the long term. Similarly, as hybrid funds invest in both equities and debt instruments their returns tend to be higher than debt mutual funds while they are less prone to short-term volatility as compared to equity funds. However, one should keep in mind that historical performance does not guarantee that the same level of performance will be maintained in the future.