Is SIP a Smart Investment for Wealth Creation? Know Why?
People often believe that investing is all about predicting market trends and gaining profit from them. But in reality, the secret to growing wealth is by consistently staying invested with patience. Systematic Investment Plans (SIPs) make it easier to build wealth over time by investing small amounts regularly. It develops a regular saving habit among individuals, which helps them grow their money.
Many people get anxious when their SIP is not doing well, especially in the short term, and out of panic, they withdraw their money to avoid further losses. However, by doing this, they miss out on one of the biggest advantages of investing in SIP, i.e., compounding.
Understanding the Power Compounding
The magic of compouding allows your money to earn more money over a long period of time. Compounding is a process where the money you earn from your investment in the form of interest adds to your original amount and then you earn returns on both your initial investment and the interest it generated. It plays a significant role in your SIP and can lead to exponential growth if you stay invested for the long term. Let’s understand this with an example.
- Suppose you invest Rs.2,000 every month in an SIP, and the average return on your investment is 12% per year. By the end of the year, you will earn interest of around Rs.1,619. This will be added to your initial amount of Rs.24,000. The total amount would be Rs.25,619. By the end of 5 years, it could generate total wealth of up to Rs.1,64,973. Over 10 years, it could build total wealth up to Rs.4,64,679.
Do SIPs have the potential to protect against Inflation?
There are high chances that it could beat inflation if you stay invested for the long term with patience. Inflation gradually reduces the purchasing power, which makes it ideal to invest in instruments that give returns higher than inflation.
Investors who are starting their journey with SIPs are advised to invest in large-cap equity funds. These funds invest in companies that have a market capitalization of more than Rs. 20,000 crore. Since these companies are financially stable, they are less affected by the market ups and downs as compared to small- and mid-cap stocks. They are less risky and are suitable for investors looking for inflation-adjusted wealth creation. However, it is also advised to explore small- and mid-cap companies as well. Staying invested only in one segment can be risky, as it’s not guaranteed that this one segment will always perform well. Diversifying your portfolio minimises risk and allows you to earn more returns.
How does SIP mitigate risk in Market Downfalls?
Just like stock markets, SIPs also carry risk associated with them during the market decline. However, it minimizes it through Rupee Cost Averaging (RCA). It is an investment strategy where an investor invests a fixed amount of money at regular intervals, regardless of the market’s ups and downs. When the market goes down, SIPs buy more units at lower prices and when the market goes up again, SIPs buy fewer units at higher prices. This strategy reduces the average cost of acquisition and over time it could lead to better returns.
Past performance data has shown that those investors who stay invested for the long term are rewarded with higher returns as compared to those who withdraw their SIP during market dips and try to re-enter it when the market starts recovering again.
One should not withdraw their investment during market downturns. Market declines can be stressful, but they are just a part of investing. Being disciplined and patient for the long term can help you grow your wealth over time.
