What is a systematic investment plan (SIP)?

SIP is a way of investing regularly in mutual fund schemes. Through this, you can invest a fixed amount (as low as Rs 100 and in multiples thereafter) monthly or quarterly for a pre-determined period in a fund. Units are allotted to you at the net asset value existing on the day of investment.

Besides mutual funds, some brokerages and gold exchange-traded funds have also started offering this option. With brokerages, you can dedicate a specific amount towards buying pre-decided scrips in tranches each month.

How to get started?
First, select the scheme, investment amount and the time frame. Next, approach a mutual fund distributor or the fund house with your application and know-your-customer (KYC) documents. You can also invest through an online mutual fund portal. Typically, fund houses mandate investment for a minimum of six months or two quarters. So, you can either give post-dated cheques for the period or opt for the auto debit/electronic clearing system option. Remember, while you can start investing on any day of the month, you will have to pick a date for subsequent investments. That is, each mutual fund specifies dates for SIPs, like the first, seventh, tenth of each month.

What are the advantages?
SIPs are highly recommended as they inculcate a habit of disciplined and regular investing. If you choose the auto debit option, the process is completely hassle-free. The most important advantage is that they follow the rupee cost averaging principle. Say, you invest Rs 1,000 a month. And, the price of the chosen scheme unit is Rs 10 in the first month. You will get 100 units.

Next month, the unit price falls to Rs 9 and you are allotted 111 units. In the third month, the price drops further to Rs 8, getting you 125 units. Thus, by investing Rs 3,000 over three months, you have got 336 units.

In contrast, had you invested the entire amount in the first month itself, you would have garnered just 300 units. In case of SIPs, the average unit cost is about Rs 8.9 as compared to Rs 10 in case of lump sum investments. Thus, SIPs help lower the average unit cost and buy you more units. All, by eliminating the need to time the market.

How are the investments taxed?
If units of an equity-oriented fund are held for more than a year, any gain arising on their sale is considered as long-term capital gain (LTCG) and, hence, is tax-free. However, if you sell them off within a year, gains, if any, are considered as short-term capital gains and taxed at a flat rate of 15 per cent. The same rules apply to SIPs accompanied by the first in-first out principle. From a taxation perspective, each SIP instalment is considered a separate investment and must be held for at least a year to be eligible for the LTCG benefit.