Is SIP Safe? Things you need to know about Systematic Investment Plans

Mutual funds are not new to the Indian market, and you’d hardly find any young investor who has not heard of SIPs. Due to the flexibility of investment offered through SIPs, mutual funds have become a staple in any investment portfolio. But are they really the safest way to invest and build a long-term portfolio? Check out this blog to learn more about whether SIPs are safe and bust a few myths along the way. 

What is SIP?

A Systematic Investment Plan (SIP) is a popular investment mode that allows investors to invest a fixed amount of money into mutual funds regularly. Investors can invest in mutual funds at fixed intervals, such as daily, weekly, monthly, quarterly, and so on, through SIPs. 

SIPs are designed to make investing accessible to investors with limited capital and prompt them into a disciplined structure of investing regularly. This principle leverages the principle of rupee cost averaging and the power of compounding to enhance returns as the investment grows in time. SIPs offer flexibility in terms of adjusting or increasing the investment amount or stopping the plan without incurring penalties. This makes them a versatile tool for achieving financial goals such as retirement, education, or wealth creation for every class of investors. 

Risks involved in Sip

SIPs are considered to be very safe and flexible investment options for investors. However, are SIPs risk-free? The answer is no. Here is a brief snapshot of all the risks associated with SIPs. 

Market risk 

Market risk is the risk of losses due to market fluctuations or factors that impact the overall financial markets. Since SIPs invest in mutual funds, which in turn invest in stocks/debt instruments which are subject to market fluctuations, the value of investments can go up or down based on the performance of the underlying assets. Therefore, during periods of market downturns, the value of SIP investments can decline, which can potentially lead to losses. 

Fund management risk

The performance of SIPs heavily depends on the expertise and strategy of the fund manager. Poor decision-making or changes in the fund management team can negatively impact the fund's performance. Therefore, it is crucial to choose funds managed by experienced and reliable professionals and check the fund's historical performance. 

Interest rate risk

SIPs in debt funds are also exposed to interest rate risk. Any changes in interest rates can affect the price of the bonds within the fund. Usually, an increase in interest rates causes bond prices to fall, which can negatively impact the fund's net asset value (NAV).

Liquidity risk

While SIPs offer flexibility in investment and withdrawal, some mutual funds may have liquidity constraints. During times of market stress or for funds investing in less liquid assets, selling holdings at a fair price might become difficult, potentially affecting redemptions.

Credit risk

Credit risk is the risk of default that may be directed towards the debt mutual funds. The fund performance can be adversely affected if the entities in which the fund has invested default on their obligations, which can impact the returns on SIP investments.

Are SIP Returns Taxable?

The tax treatment of Systematic Investment Plan (SIP) returns depends on the type of mutual fund and the holding period. For tax treatment, the fund is primarily classified as an equity or debt fund. This classification is based on the asset allocation of the fund. If the fund has allocated more than 65% in equity, it is termed an equity-oriented fund, and a fund having 65% or more in debt securities is termed a debt fund.

The tax treatment of equity and debt funds is tabled below for better understanding. 

Does SIP have a lock-in period?

SIPs in general, do not have a lock-in period. Investors can start and stop their SIPs at any time without incurring penalties or restrictions. However, some underlying mutual funds in which SIP investments are made may have their own lock-in periods. For example, Equity Linked Saving Scheme or ELSS funds have a lock-in period of three years. Therefore, the SIPs will follow a similar route in such cases. Therefore, investors need to review their mutual fund scheme's specific terms and conditions to understand any applicable lock-in conditions. 

Is SIP good for the long term?

Yes, SIPs are generally considered beneficial for long-term investors. They provide a disciplined approach to investing by allowing investors to contribute small amounts regularly, which can accumulate significantly over time. Investing in the long term through SIPs also helps mitigate the risk of short-term volatility and harnesses the power of compounding, which is the single most efficient way to grow a long-term corpus. 

Conclusion

SIPs are an excellent investment option, especially in India, where investors belong to different economic, demographic and income levels. They help gradually build the investment portfolio to meet the financial goals without severely burdening the immediate or current financial stability. This allows more retail investors to be part of the financial markets and thereby participate in the country's growth story and wealth creation.