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SIP vs RD – Which is better?

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SIP vs RD

Really, there is no “better” option when it comes to investments.  The investments you want to make should be suited to your lifestyle, needs and comfort with risk.  People who have the ability to invest small amounts of money on a regular basis have many options, two of which are Systematic Investment Plans (SIP) and Recurring Deposits (RD).

Here we take a look at SIP and RD, so you can analyse the benefits and risks to determine which one would work better for your financial goals.

SIP is an investment strategy offered by mutual funds to investors. An SIP allows you to invest small amounts of money regularly rather than a single large amount all at once.  This money is then used for investment in certain schemes in the market.  You then earn returns on your SIP that are dependent on how well the market is performing.

RD is a deposit product offered by banks and post offices in India.  Like SIP, you can invest small amounts of money regularly rather than a single large amount all at once.  If you open an RD, you  invest a fixed amount of money every month for a predetermined duration. At the end, you get back your original investment amount plus the interest that has accrued.

How SIP works?

Pay a fixed amount of money into a Mutual Fund scheme on a periodic basis, which can be daily, weekly or monthly etc. whichever is best for you.  You are able to stop investing in a plan at any stage, or increase or decrease the investment amount at your will.

The amount you have paid into your SIP gets invested according to the schemes you have chosen – these could be debt, equity, debt-equity schemes etc.

Because an SIP is a mutual fund investment technique, the returns you get are linked to markets and asset allocation strategy.  The value of your investment can be determined thusly:

Investment Valuation = Investment Amount + Profit/Loss

If you invest in an SIP, you will regularly receive units of the Mutual Fund, depending on the prevailing price (NAV or Net Asset Value).  Every month – and whenever the NAV changes – you will get a different number of units.

These units have an inverse proportionality to the profit experienced: when the NAV is high, you will get lower number of units and when the NAV is low you will get higher number of units.

SIPs work well for long and medium term investors.

The positives:

  • Market volatility is less of a concern for SIP investment than shares, as these plans capture market fluctuations to offset the negative effects of an unpredictable market cycle.
  • You can choose the scheme in which your money is invested.
  • You can withdraw from an SIP without incurring financial penalties, so there is higher liquidity of your investment.
  • You will not have to pay tax on dividends you receive from your investment.

The negatives:

  • You won’t get a fixed rate of return as you will with RD – though the rate of return can be higher than RD, this is not something you can use to plan your financial future to the last dollar.
  • You will have to pay capital gains tax on the returns you receive from your investments.

How RD works?

Pay a selected amount of money (minimum amount) into your account, every month on a pre-specified date.  After your initial month, you pay your minimum amount per month, plus any additional amount you’d like – in multiples of 100.  You cannot change the original minimum installment amount during the tenure of the RD.

Your RD account can be open for a minimum of 6 months, and a maximum of 10 years – or anywhere between those time periods as long as it is a multiple of 3 months (ie, 9 months, 18 months etc.).  However, you are not permitted to withdraw your money before the end of tenure without facing penalty.

You cannot choose a scheme to invest in.  The money you pay into an RD is simply held by the bank while it earns interest.

An RD has the same interest rate as an FD (fixed deposit) of the same tenure, and its value can be determined thusly:

Maturity Value = Total Investment Amount + Accrued Interest

The positives:

  • A fixed return for better financial planning.
  • Tax payable on an RD is at a marginal rate.
  • Senior citizens get an additional 50 basis points for their interest rate on their RD.

The negatives:

  • Premature withdrawal from your the RD will incur penalty rates, so there are less options to liquidise your investment.
  • RDs give lower returns than SIP.

A comparison of SIP and RD

 

FACTORS SIP RD
Payment frequency Is flexible – choose how often you want to deposit funds. Inflexible – you must pay your selected minimum amount per month.
Investment choice Choose how to invest your money – equity, debt etc. No choice of investment scheme.
Rate of return Is generally higher, however cannot be assured due to market volatility. Is fixed at the date of opening the RD.
Liquidity of funds Withdraw funds before tenure with minimal penalty. Premature withdrawal of funds will incur penalty rates.
Overall risk Higher risk as the money is used for market linked products and is therefore subject to fluctuations or loss in the market. Low risk as return is fixed per month, and the money is held by the bank.

So which is better for you?

It is generally said that those with a higher income and more money to play with, are better off with an SIP account.  The returns are higher, however as the market is volatile, your return rate is not the same amount every period.

Those who are very young or senior citizens, will feel more comfortable with a RD account.  An RD account makes financial planning easy and is not subject to any changes that happen in the market.  An RD account can help young people learn good finance habits by making a deposit every month and saving money.  A senior citizen can be assured in the amount they will receive from their investment.

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1 COMMENT

  1. This is a very nice and detailed tutorial which I can use for future reference. I do have a recurring deposit and was well aware of that it is and how it works. SIP was a new term and am so glad that I understood it completely. Thanks author, for enhancing my knowledge!

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