Systematic Investment Plans (SIPs)

Systematic investment plans or SIPs as they are known popularly are the investment vehicles offered by various mutual funds across the world. If you are in the world of investing, then you must have come across the jargon of ‘timing the market’. In layman terms this suggests that you should have acumen of judging the right time to enter and similarly the right time to exit from the bourses. But this seemingly innocuous principle is the most difficult art to exercise. For this, you need to follow the markets religiously and also you should have an expertise in your respective area. Thus SIPs provide you a easy way out, when you do not need to worry about the vagaries of market, and can keep on accumulating wealth nonchalantly.

For whom SIPs are for?

Systematic investment plans are for those investors, who do not wish to play with the volatility of the market and do not have the desire to ‘time the markets’. It’s a conservative way of investing, and mind you not trading, because traders are never going to draw out any benefit from it. These are generally used to meet the long and mid-term investment goals of the investor as they hardly give attractive returns in the short time horizon. If you are an investor, who want to accumulate wealth, but do not want to scratch your head following the fickle market, these products should be in your kitty.

How does SIP work?

The fundamental working of SIP is similar to the EMI which you pay on the monthly basis. When you subscribe to a Systematic investment plan, a pre-decided monthly contribution gets debited from your account which is linked to the MF Account. The minimum amount of installment depends from fund-to-fund, but generally these come with the base installment of Rs1000 with installments in the multiples of 1000.

How does SIP add Value?

The Principle on which SIP works is “Rupee Cost Averaging”. Let us dwell on this a bit further, as you may be aware that Mutual Funds are traded in the form of units. At the end of trading day, as mandatory by SEBI, every MF declares its Net Asset Value (or NAV). NAV is the total value of the units of the mutual fund in the market. Thus when you wish to invest some amount in MF, say Rs 1000, then the NAV of MF is divided by 1000, and you get the units worth Rs 1000. Thus, the crux is, the number of units which you get depends on the NAV of the fund.

Now in the case of SIP, since you are investing a fixed amount every month, thus your number of units attained every month will differ according to the NAV of the fund in which you are investing. Thus during the bullish time, the units attained by you would be less due to the higher NAVs of the fund, while during negative sentiments, you get more units for your contribution due to dip in NAVs.

Let’s understand it with an example:

• Investor A has invested lump-sum amount of Rs 10,000

• Investor B is investing Rs 1000 every month

Month Investor A Units Purchased Investor B Units Purchased Unit Price

1 10000 1000 1000 100 10

2 0 0 1000 105.3 9.5

3 0 0 1000 114.3 8.8

4 0 0 1000 115.6 8.7

5 0 0 1000 118.3 8.5

6 0 0 1000 125 8

7 0 0 1000 117.6 8.5

8 0 0 1000 107.5 9.3

9 0 0 1000 95.2 10.5

10 0 0 1000 90.9 11

Total Investment Rs.10000 1000 Rs. 10000 1089.8

Total Value Rs.11000 Rs. 11988

As evident from the table, with the time elapsed, the value of A Systematic Investment plan increases in comparison to deposit money in a lump-sum amount.

Another advantage of SIP is the benefit of time compounding which gets accrued to the investor. Thus, in a window of 15-20 years, a substantial amount of corpus gets accumulated.

Why SIPs are Beneficial?

• It inculcates the habit of saving regularly, which helps in maintaining discipline and thus helps a lot in the wealth creation for meeting targets.

• It discourages investors from timing the markets, which is actually beneficial for them due to lack of their acumen and expertise.

• It averages out the dips and rises of the market, so that investor’s money remains fairly secured.

• It accrues the benefit if time compounding to the investors.

“Remember!!… a rupee a day.. Will keep your worries away “….

Smart Investing(Fixed maturity Plans or Fixed Deposits)

Fixed Maturity Plans Vs FD

Fixed Maturity Plan (FMP):

These funds are closed ended fund with a pre defined maturity such as monthly, quarterly, half yearly or annually & have most of the investment in debt instruments.

FMP invest in fixed income securities like Govt. Securities, Corporate Bonds, CP (Commercials Papers), CD (Certificate of Deposits) and other debt instruments.

Features of FMP:

• Competitive tax efficient return with min risk
• Available for different time period
• Good for those investors who look for steady and predefined maturity & tentative return.
• FMP usually have expense ratio between 0.25% to 1%
• To avoid early redemption FMP have higher exit load anywhere between 1% and 3%

Tax Implications:

• There are different Taxation aspects depending upon Investment Scheme like growth or Dividend options.

Dividend Distribution Tax

Ø For Individual Investor: 14.025%

Ø For Corporate Investors: 22.44%

• Short Term Capital Gain: If you invest in the Growth option of the FMP for less than 1 year, the gain is added to the Investor’s Income and Taxes at the Investor’s Income Tax Slab rate.
• Long Term Capital Gain: If you invest in Growth Option of FMP for over a year, you pay either 10% capital gains Tax without indexation or 20% with Indexation.

Indexations Benefit:

Indexation: Indexation is a technique to adjust income by using price Index.

As the year passes price also rises so actual price should not be used while calculating profit or gain rather it should be indexed as per the Inflation in the country so people can know real gain.

Indexed Purchase Price=

Purchase price*(cost of Inflation Index for Current year/Cost of Inflation Index for purchase year)

Now taking the advantage of Indexation we can save our Tax on LTCG.

Ex:

Suppose you have invested in FMP for 370 days @ 9.5% return

You have invested on 29^th March 2011 and this FMP will mature on 2^nd April 2012

The above Investment comes under financial year 2010-11, FY-11-12 & FY12-13.

It passes through two financial years so investor gets double Indexation benefit.

DTC(Direct Tax Code) Situation:

Considering to DTC Implication holding period is important in Current Tax scenario.

Holding period will start from end of financial year in which the asset is purchased irrespective the asset is purchased on 1^st Oct 2010 or 1^st March 2011, holding period will start from 1^st April 2011 and to consider Investment as a Long term it should sold after 31^st March 2012.

Let us an example: If the Investment is made on 1^st Sep 2011 and mature on 4^th Sep 2012.

Financial year Starts from 1^st April 2011 and end to 31^st March 2012 another Financial year 1^st April 2012 to 31^st March 2013.

In above situation investment does not pass through any financial year so no Indexation benefit on above investment, it will not come under LTCG irrespective of 12 months above holding period.

This is the drawback in FMP if the DTC (Direct Tax Code) comes.

Comparison Sheet of FD Vs FMP:

Let us take an Example of FMP with following features:

A) For 498 Days FMP with 9.56% return.

Invested on 25^th March 2009 and maturity on 5^th Aug 2010.

Considering Investor is in highest Tax Slab.

Working:

Indexation benefit:

FY2008-2009, FY-2009-2010, FY-2010-11

CII For

FY CII

FY-2008-09 582

FY-2009-10 632

FY-2010-11 711

A) FMP, 498 Days Invested on 25 March 2009 and Maturity on 5 Aug 2010.

498Day FMP with 9.56% Return

(Considering Investor is in highest Tax Slab.)

	Bank FD	FMP		FMP Divd Option
	Bank FD	With Indexation	Without Indexation
Amount of Investment(Rs.)	10000.00	10000.00	10000.00	10000.00
Indicative Yield	9.56%	9.56%	9.56%	9.56%
holding Days	498	498	498	498
Maturity Amount	11304.35	11304.35	11304.35	10000.00
Divd(Rs)				1304.35
Gain	1304.35	1304.35	1304.35	1384.85
Indexed Cost	NA	12216.49	NA	NIL
Indexed LTCG/Loss Adjusted for Indexation	NA	-912.14		NA
Tax Rate	33.66%	33.66%	11.22%	14.03%
Tax	439.04	0.00	146.35	194.29
Post Tax	865.31	1304.35	1158.00	1190.56
Post Tax Ann Return	8.44%	12.73%	11.30%	11.62%

The above table depicts that FMP (Growth Option) with more than 1 year is better than FD having higher post Tax return.

B) FMP OF 90 Days Invested on 25 March 2009 and Maturity on 23 Jun 2009

90Days FMP, Yield 9.56%

	Bank FD	FMP Growth Option	FMP Divd Option
Amount of Investment(Rs.)	10000.00	10000.00	10000.00
Indicative Yield	9.56%	9.56%	9.56%
holding Days	90	90	90
Maturity Amount	10235.73	10235.73	10235.73
Divd(Rs)			235.73
Gain	235.73	235.73	235.73
Tax Rate	33.66%	33.66%	14.03%
Tax	79.35	79.35	29.00
Post Tax	156.38	156.38	206.73
Post Tax Ann Return	6.34%	6.34%	8.38%

The above table depicts that FMP (Dividend option) for less than 1 year is better than FD having higher post Tax return.

Conclusion:

• If investor falls in highest Tax Slab then he can invest in FMP Growth or Dividend option to earn higher post Tax return compared to FD.
• In FD return is fixed but in FMP maturity period is fixed so in investors must take consideration of his risk appetite.
• For FMP more than 1 year Growth option is good but for FMP less than 1 year Dividend option is good to get post tax return.

Happy Investing!