Mutual Funds and Systematic Investment Plans (SIPs) are interrelated, but very different concepts.
A Mutual Fund is an investment, whereas an SIP is a method of investing. SIP is mostly associated with Mutual Funds however, theoretically, you could invest into anything at all systematically. For the purpose of this article, we will discuss what Mutual Fund and an SIP are, the primary points of difference between the two, and how they interconnect.
What is a Mutual Fund?
To put it in very simplistic terms: Think of a basket of chickens that is held by a farmer. You and a group of 10 friends pool your money and give it to the farmer. The chickens then lay some eggs, which the farmer sells. At the end of the egg-laying season, you and your 10 friends will get a portion of the money the farmer made from selling the eggs. This basket of chickens is the Mutual Fund.
A Mutual Fund (MF) is a portfolio, or a “basket”, of different market-related products (such as stocks and bonds) that is managed by a professional. Shares of the portfolio are made available for purchase by investors - people like you, and the person next door.
An MF allows you to invest your money in shares/bonds or other market-related products, without buying the individual market products yourself. At the end of each day the MF’s holdings are priced and the value of the portfolio is calculated, and as an investor, you get a share of the profits.
You can invest in an MF in two ways: through a lump sum or through an SIP. Next, we will look at investing in an MF with an SIP.
Investing in an MF with an SIP
Like making installments in a Fixed Deposit, you contribute a set amount on a regular basis to the MF. When the MF makes money by trading on the market, you are entitled to share of those profits.
By depositing into an MF on a regular basis, you can reduce the average cost you pay per market-related product (such as a share or a bond). Also, when you pay a small amount into an SIP over a defined period, it is easier to stick with your financial plan and to achieve your investment goals.
SIPs are meant for very long term investments to assist in increasing the investor’s returns over a long period of time.
Additional notes on Lump Sum investments in MF
The question is bound to arise: “which is the best way to invest in a Mutual Fund?”. There is no “best”, the investment method it is dependent on the risks you want to take versus the returns you hope to yield.
Investing in an MF with a Lump Sum has an element of timing involved. Your return on investment is based upon the value of the portfolio at the date of investment. Lump sum investment is far more risky due to market volatility. You may experience loss or an element of regret if the value of the portfolio increases only days after your invest a large amount of money. This is why SIP is the least gut-wrenching way of investing in MFs. To make a lump sum investment, it is ideal to have a good bearing on market behaviour of the Mutual Fund in which you are going to invest.
Recommended Read :
- What is SIP (Systematic Investment Plan)?
- What are Mutual Funds?
- How Does a Sip Work?
- Sip Vs Mutual Fund
- Methods to Select the Best Mutual Funds
- Types of Mutual Funds in India
- 5 Types of Popular Mutual Funds in India
- Understanding Mutual Funds Returns?
- Fixed Deposit Vs Mutual Fund
- Real Estate Vs Mutual Fund
- SIP Vs Mutual Fund
- Mutual Fund Investment Strategy
- Mutual Funds in India
- What is Net Asset Value (NAV)?
- Open Ended Mutual Fund Scheme
- Close Ended Mutual Fund Scheme
