Is it normal if SIP returns are low in the initial years?

1. What is SIP?

A common saying goes, "drop by drop, the bucket fills up." A SIP operates on the same principle. A Systematic Investment Plan, or SIP, invests through mutual funds that offer a variety of schemes suitable for each type of investor. Individuals seeking long-term capital appreciation or even who want to park their money for a short term should consider SIP investments. The SIP facility allows you to invest a fixed sum of money in a mutual fund scheme at pre-determined intervals like weekly, monthly, quarterly, semi-annually or annually. The fixed sum may be as low as Rs.100 p.m. for monthly SIP. By investing in a SIP, the investor invests in a time-bound manner without worrying about market fluctuations and stands to gain in the long run due to cost averaging and compounding capacity.

2. How does SIP work?

When you make a SIP investment in a mutual fund scheme, you buy a certain number of fund units depending on the sum you put in and the price of a unit. When you invest in a SIP, you don't have to time the markets to start your investments. When markets are down, you buy more fund units, while when the markets are up, you buy less. Since all mutual funds unit prices depend upon the market value of their fund portfolio, the purchase cost will differ from one SIP instalment to the next. The cost of purchase averages out over time, this is called Rupee cost averaging.

Additional Read: ICICI Direct- SIP

3. How does SIP generate money?

The compounding and rupee cost averaging amplifies the benefits of investing periodically by SIP and for the long term. The compounding effect means that you earn returns not only on your principal amount (actual investment) but also on the generated returns. The gains on your principal amount is added back to the principal over time. Even small investments can benefit from compounding's power to develop and yield decent returns in the long run.

You can benefit from compounding if you invest this way for a long time and progressively increase the monthly SIP as your income grows.

Investors should be aware that building wealth is almost impossible to achieve overnight. The longer your investment horizon is higher is the impact of compounding. It's never too late to begin a mutual fund SIP. You will automatically have more years to develop a corpus if you start early. Besides this, you can benefit from the increasing unit price over the tenure of SIP. The investors also enjoy the benefit of rupee-cost averaging, that is, buying more units in a low market (low NAV of Mutual Fund) and less units in a blooming market (higher NAV) which averages out the purchase price per unit on the lower side.

4. Initially, will I get low returns?

When trying to reap the benefits of compounding, one must be patient to see the voluminous results. Initially, the investments might look slow on their returns. For example, a SIP of Rs. 1000 per month in an equity mutual fund for ten years might give little returns in the initial years before you could experience the magic of actual returns over time due to compounding. The main point to be noticed here is that the market determines your returns in the initial years and compounding does wonder in a longer period. When you have a long-term view, don't be concerned with initial period returns; also, don't be overly pleased if the returns are substantial. Keep the SIP going as per your defined tenure.

In recent years, SIP has been the preferred method of mutual fund investing. You can set aside small amounts each month for investment in SIP without disturbing your monthly budget. You must tread with caution while choosing the mutual fund scheme. Choose an appropriate mutual fund scheme based on your financial goals and investment horizon and let your investment do the work while you enjoy your life.