Difference Between SIP and Mutual Funds: Benefits, Risks & Which is Better?
Mutual funds serve as an investment avenue where a fund manager pools money from investors to invest in various assets like stocks and bonds. These funds, actively or passively managed, spare investors from the need to select specific stocks or commodities. Instead, professional analysts, led by the fund manager, handle the management and operation of these funds.
Investors, in turn, have flexibility in their investment approach. They can opt for a lump sum payment or choose a Systematic Investment Plan (SIP). A SIP is not a standalone product but rather a method of investing in a Mutual Fund scheme. Understanding the distinctions between Mutual Funds and SIP is crucial for anyone embarking on an investment journey. In this blog, we will explore the difference between SIP and Mutual Funds.
What are SIP Investments?
SIP, short for Systematic Investment Plan, is a method of systematically investing in mutual funds over time. Unlike mutual funds, SIP operates within the mutual fund framework. It instills investment discipline by facilitating regular, small deposits into a chosen scheme. Investors can opt for various frequencies—daily, weekly, monthly, fortnightly, or yearly—to build a corpus according to their financial goals. Once a frequency and date are selected, the investment amount is automatically debited from the investor’s bank account. This approach ensures a systematic and structured investment process. However, there is also SIP in stock investments which can break down your investment journey into systematic steps.
What are Mutual Funds?
A mutual fund, created by an asset management company (AMC), allows investors to own units in proportion to their investment. Investors choose between equity, debt, or hybrid funds based on their risk tolerance and financial goals.
Mutual funds provide diversification, spreading investments across asset classes for a balanced portfolio. This mitigates risks associated with one asset class, preventing the loss of the entire investment during turbulent periods. Professional fund managers handle portfolios, making strategic decisions based on market trends and timely research.
ELSS mutual funds offer tax benefits under Section 80C of the Income Tax Act, 1961, allowing a maximum investment of Rs 150,000 per financial year for deductions. Investors can choose between lump sum and Systematic Investment Plan (SIP). Lump sum is a one-time investment, while SIP involves regular fixed investments at intervals over a selected period. Let us now explore the mutual fund and SIP differences.
Difference Between SIP vs Mutual Funds
The difference between SIP & Mutual Funds are many and we have made a tabular comparison of the two investment methods. Here is the difference between SIP and Mutual Funds:
| Criteria of Comparison | Mutual Funds | SIP |
| Definition | Professionally managed investment scheme | Investment technique with fixed periodic sums |
| Administration | Run by an asset management company (AMC) | Applied universally across various investments |
| Objective | Aims to grow investors’ money | Systematically invests fixed sums at intervals |
| Applicability | Invests in stocks, bonds, gold, and securities | Applies to Mutual Funds, PPF, fixed deposits, etc. |
| Mechanism | Pools money from multiple investors | Invests fixed sums at pre-specified intervals |
| Flexibility | Offers flexibility in choosing asset classes | Universally applicable across different assets |
| Recommended Approach | Considered a recommended investment strategy | Widely recommended for Mutual Fund investments |
| Clarity | Transparent mechanism for growing investments | Enhances clarity through systematic investment |
Now that we know the difference between SIP and Mutual Funds, let’s find out how SIPs work in Mutual Funds.
How Does SIP Work in Mutual Funds?
Now that you grasp the basics of mutual funds and SIP, let’s delve into how SIP in mutual funds operates.
With SIP, you consistently invest a fixed amount, automatically deducted from your bank account. The fund house processes your transaction, and you receive mutual fund units based on the current NAV.
As you make subsequent SIP investments, you accumulate more units at the prevailing NAV for each day. To illustrate, let’s consider an example to illustrate this process.
Advantages of Investing in SIP
In order to understand what is difference between mutual fund and SIPs, it is important to understand the benefits of each. SIPs offer several key benefits:
- Rupee Cost Averaging: Inspired by Dollar Cost Averaging, Rupee Cost Averaging allows you to invest small amounts regularly, averaging out investment costs over time. For instance, investing a fixed amount each month ensures buying more shares when markets are cheaper and fewer when expensive.
- Investment Discipline: SIPs promote a disciplined approach by requiring a fixed monthly investment, fostering a habit critical for long-term financial success. This approach outperforms lump sum investing, especially in terms of wealth-compounding benefits over decades.
- Convenience: Easily set up and managed, SIPs automatically deduct the investment amount from your bank account monthly, providing a hassle-free investment option, ideal for those with busy schedules.
- Flexibility: Offering the freedom to choose investment amount, frequency, and duration, SIPs enable tailoring investments to specific financial goals. In India, starting a SIP with as low as ₹500 a month provides accessibility.
Advantages of Investing Mutual Funds
In order to explore the SIP and Mutual Fund difference, let’s also look at some benefits of investing in mutual funds. Here are a few benefits of mutual funds:
- Active Management for Efficient Investing: Instead of investors spending time and effort on researching individual stocks or bonds, mutual funds offer a solution. Professional money managers, equipped with expertise and resources, actively handle the buying, selling, and monitoring of investments in mutual funds. This proactive portfolio management ensures alignment with the fund’s objectives, providing investors with a crucial advantage.
- Smart Risk Management through Diversification: Investing in a mutual fund allows easy diversification across various securities and asset categories like equity, debt, and gold. This strategic spread minimizes risk, preventing a significant impact if one component faces market challenges. Even if one investment declines, others may hold or increase in value, demonstrating the fundamental advantage of risk diversification in mutual fund investments.
- Accessibility and Cost-Efficiency: Purchasing all the individual securities within a mutual fund independently could be costlier for many investors. However, mutual funds have lower entry barriers with more affordable minimum initial investments, making them accessible to a wider audience.
- Quick and Flexible Liquidity: Open-ended mutual funds offer convenient liquidity, allowing investors to redeem units to meet financial needs on any business day. The redemption process swiftly credits the amount to the investor’s bank account within 1 to 3-4 days. It’s important to note that close-ended mutual fund schemes can only be redeemed upon maturity, and ELSS units have a 3-year lock-in period before liquidation becomes an option.
Risks of Investing in SIP
Embarking on an investment journey is a promising way to grow wealth and fortify financial security. However, it comes with inherent risks. Understanding these risks is crucial for investors. Furthermore, the difference between SIP and Mutual Funds can be defined with more precision if we understand the risks of investing in SIPs.
- Market Risk: Market risk, synonymous with systematic risk, stems from the overall financial market performance. Economic conditions, geopolitical events, and market sentiment can sway investments, particularly in stocks and equity-based mutual funds.
- Credit Risk: Credit risk, or default risk, surfaces when bond issuers fail to meet interest payments or return the principal. It’s pertinent in corporate bonds, municipal bonds, treasury bonds, and
- Inflation Risk: Inflation risk jeopardizes the purchasing power of money due to rising inflation, eroding the real value of fixed-return investments like bonds or savings accounts.
- Interest Rate Risk: Interest rate risk manifests when changes in interest rates impact the value of fixed-income investments. Bond prices generally fall when interest rates rise, and vice versa.
- Liquidity Risk: Liquidity risk arises when buying or selling an investment impacts its price, prevalent in less-traded stocks, real estate, or certain alternative investments.
Risks of Investing in Mutual Funds
Embarking on the journey of investing in mutual funds offers potential rewards, but it’s crucial to be aware of the accompanying risks of investing in mutual funds. The difference between SIP and mutual funds can be explored in more detail when we explore the risks of investing in mutual funds, as well:
- Market Volatility: Mutual funds are susceptible to market fluctuations, impacting fund values and returns, particularly during economic downturns.
- No Guaranteed Returns: Unlike traditional savings instruments, mutual funds don’t assure fixed profits. Returns are subject to market dynamics and fund performance.
- Dependency on Fund Managers: Fund managers’ decisions can significantly influence outcomes, and their strategies may not always align with market movements.
- Liquidity Risk: While mutual funds offer redemption flexibility, the actual process may take time, especially for open-ended funds, exposing investors to liquidity risks.
- Past Performance ≠ Future Results: Historical performance is informative, but market conditions change, and past success doesn’t guarantee future profitability.
To Wrap It Up…
In conclusion, the debate between Mutual Funds and Systematic Investment Plans (SIPs) hinges on individual financial objectives and preferences. Mutual funds offer diversification and professional management, catering to varied risk appetites. On the other hand, SIPs provide a disciplined approach to investing, allowing for rupee-cost averaging. Use the smallcase SIP calculator to calculate your details.
Understanding the distinctions is crucial for investors. Mutual funds, with their range of options, suit those seeking diversity, while SIPs are favored by those prioritizing disciplined, periodic investments. Both avenues have their merits and considerations, emphasizing the importance of aligning choices with one’s financial goals and risk tolerance.
FAQs
A mutual fund and SIP differ significantly. A mutual fund pools money from diverse investors to invest in various assets. On the other hand, SIP is a way of regularly investing a fixed amount in mutual funds.
It is not fair to discuss mutual fund vs SIP which is better, because Mutual funds and Systematic Investment Plans (SIPs) serve different purposes and the diff between SIP and Mutual Funds are many, and hence, are not comparable. Mutual funds provide a diversified portfolio managed by professionals, while SIP is an investment approach specifically for mutual funds.
Apart from ELSS investments eligible for a Rs 1.5 lakh deduction under Section 80C, SIPs in other mutual funds do not enjoy tax exemption. When you redeem your SIP, capital gains are taxable. Equity funds incur a 15% STCG tax and a 10% LTCG tax. For debt funds, LTCG and STCG are taxed based on your income tax slab.
Yes. You have the flexibility to withdraw or redeem your SIP at any time, with the exception of ELSS funds that have a mandatory 3-year lock-in period. Keep in mind that some fund houses may impose charges for early redemption, and exit loads are not applicable to all mutual funds.
Investors seeking control and higher returns often turn to direct stock market investments, which, while promising, carry elevated risks requiring thorough research. In contrast, mutual funds offer professional management, diversification, and convenience, making them an appealing choice for many.
