Mutual Funds

Mutual Fund Investing with SIP – Benefits, Rupee Cost Averaging & Taxation

A SIP (Systematic Investment Plan) is a popular method of investing small amounts in mutual funds, trading accounts or retirement accounts regularly. It helps investors to develop the habit of investing as well as saving. There are various benefits of SIP in mutual funds, the most important being the freedom to choose the number of funds that can be invested in periodically. Some of the other major benefits are discussed below:

Compounding your benefits

When the funds are invested regularly in mutual funds through SIP, the returns compound for a longer period. When you invest through SIP, the earned gain is reinvested and that leads to higher growth on return on investment. Let’s take an example to understand –  Rs 5,000 is invested by Amit through SIP for 10 years then the amount earned will be Rs. 13,76,085 with an assumed rate of return of 15%.

Rupee Cost Averaging

Rupee cost averaging simply means averaging out the cost. In SIP, the investment amount is fixed so investors can buy more units at a low price and when the markets are high, the units are purchased in less numbers. Hence this averages the whole cost of a particular unit and helps in reducing the risk and increasing the returns in the end. For example Amit has invested Rs 10,000 of  SIP in a month then will have following rupee cost averaging calculations:

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In the above table as we can see that the units invested changes with volatility of the market. Here the average NAV comes to 97 (387/4) which is less than 100 (10000/100) and the units invested  is 414 in place of 400.

 A Friend in need

In changing times, the SIP helps in meeting the contingent needs of investors. We know that saving a big amount is a bit difficult but small amounts can be saved easily and then the accumulated funds can be used in case of emergency. SIP is a disciplined way of investing as the pre-decided amount is invested in a fixed set of units regularly. The best part of SIP is that the amount can be stopped and started at any time and due to rupee cost averaging the market risk is also reduced.

As we have already discussed the advantages of investment through SIP. Let’s discuss the taxation part of the SIP in mutual funds. It is really important to note that the short term and long-term capital gains are taxed differently.

SIP and Taxation

So now we will specifically discuss the taxation of capital gains when invested through SIPs. Investors enjoy the fun of customization as the frequency of the SIP investment is flexible. It can be weekly, monthly, quarterly, bi-annually, or annually and in a different number of units.

Let’s Consider one example to understand the taxation of SIP investment, Priya is a 25-year-old IT professional staying in Bangalore and has decided on investing in an equity fund through a SIP for one year. Now here the gains earned from the SIP will be considered as long term capital gains and will be exempted if less than Rs 1 lakh and will be taxed 10%. The table below shows the different rate of taxations according to type of fund:

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It is clear from the above example that SIP cannot be completely tax-free. Although there is one investment vehicle that provides all the SIP benefits as well as a tax benefit and that is the Equity Linked Saving Scheme (ELSS). ELSS provides benefits of wealth creation as well as tax deduction under section 80 C. Investors can enjoy tax deductions of up to Rs 1,50,000 in a year.

Last but not least

SIP is a hassle-free way of investing as SIP doesn’t have a lock-in period and investors can have more than one SIP at a time. Hence you can create wealth from a bare minimum amount.

Points to note

  • SIP is the method of investing and not a tool for investment.
  • SIP is an attractive option for new and young investors.
  • The SIP Taxation varies from fund to fund as every instalment is considered fresh and the taxation is different
  • ELSS is the mutual fund investment tool that helps in tax saving.
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