Can mutual funds help create wealth for your future? Long-term investment in SIPs in small amounts makes it possible

As an emerging economy country, we prefer saving to spending, unlike the developed economies. Whether putting our savings in a fixed deposit (FD) or Public Provident Fund (PPF) or cutting down expenses to manage a home loan equated monthly installment (EMI), savings is all that we do. But is this saving enough to meet the future expenses especially when most of the saving instruments may at best fetch you 8-9 percent return, and inflation is 4-5percent?

What you save from your monthly salary is just not enough to meet the big-ticket expenses of the future like education of children, their wedding, your retired life, etc. It is imperative to put your savings into investment avenues that can grow manifold over the long-term. The best way to achieve this is through disciplined and regular investing.

The Systematic Investment Plan (SIP) offered by mutual funds is a great way to start investing regularly even if the amount is small and gradually build wealth in the long run.

 Can mutual funds help create wealth for your future? Long-term investment in SIPs in small amounts makes it possible

Representational image. Reuters

The SIPs have become popular with regular investors for a variety of reasons. Here is a list of positives that you just can’t afford to ignore.

1) Cheaper on the wallet as one can start a SIP with as low as Rs 500 per month.

2) Diversification is possible even with a small amount of investment.

3) Investing through a SIP makes market timing irrelevant by ensuring that one invests at all points of times (highs and lows) in the market thus averaging out the per unit cost.

4) Benefit from the power of compounding over longer periods of time.

Now let’s look at some of the distinguishing benefits of SIPs in detail.

All the mutual funds have an element of risk attached to them as they invest in market-related instruments. However, when you invest through the SIPs in the mutual funds, you can beat market volatility effectively through rupee cost averaging. This means you buy more units when the net asset value (NAV) is low and lesser units when the NAV is high. In the long run, if the market has gained, the average cost of units tends to be lower than the prevailing NAV. For example, if you invest Rs 1,000 per month, you get 100 units if the NAV is Rs 10 and 200 units if the NAV drops to Rs 5.

In the longer periods of time, the average price per unit will fall, if the markets move in both directions thus helping lower volatility of returns as well.

One can create wealth by investing in the SIPs in small amounts for longer periods of time and benefit from the power of compounding. What this means is that the return you make in the first month gets reinvested into your principal (monthly SIP amount) in the second month and this continues over many years thus enhancing the value of your investments. The longer you remain invested in the SIPs, the more you can benefit. Hence, investing in the markets through the SIPs in mutual funds in the long-term can help you accumulate wealth.

Let’s look at a simple example to illustrate this. Suppose, you invested Rs 1,000 per month in an equity fund at 8 percent compounding rate per annum for 20 years, the final amount you would get is Rs 5.89 lakh on a principal of only Rs 2.40 lakh (Rs 1000 X 240months). The same SIP, if extended for another 5 years to a 25-year time frame, gives a final amount of Rs 9.51 lakh indicating the power of compounding over longer periods. The principal invested over a 25 years period is only Rs 3 lakh. (This example is just for reference purpose and should not be taken as an absolute value. Returns in mutual funds are not fixed and there’s no guarantee.)

There is no specific time to start a SIP. The earlier the better. The longer the better. The SIPs are the answer to a common man’s financial goals.