An SIP operates similarly to a recurring investment, automatically deducting an amount from your bank account and investing it in the mutual fund of your choice. The fund house periodically allocates a certain number of mutual fund units to you once you deposit the amount. The allocation of number of units depends on the Net Asset Value (NAV) of the fund. The SIP works on two broad principles:
- 1.Rupee Cost Averaging: This allows you to manage the market's volatility by averaging out your investments. When markets are rising, you will receive fewer units; when markets are falling, you will receive more mutual fund units. As a result, it reduces investment risk and ensures you stay invested at the lowest average cost per unit, which benefits you in the long term.
- 2. Compounding: If you invest for the long term, you can reap exponential benefits. The capital invested and the returns generated from the investment get reinvested, hence yielding more returns every time as your investment amount increases. Hence, the earlier you start investing, even with a smaller amount, you will reap more benefits.