How Does SIP Work?
A Systematic Investment Plan (SIP) works through an automated process where a fixed amount is deducted from your bank account and invested in your chosen mutual fund on a specified date every month. Each SIP instalment buys units at the current NAV of the fund on that day. Over months and years, these units accumulate, and the value of your portfolio grows as the NAV of the fund increases through investment gains.
Step-by-Step Mechanics of SIP
- Setup: You choose a fund, SIP amount (e.g., Rs 5,000), and a date (e.g., 10th of every month).
- Auto-debit mandate: A NACH (National Automated Clearing House) mandate is set up with your bank to debit the SIP amount automatically.
- Monthly investment: On the 10th of each month, Rs 5,000 is debited from your account and used to buy units at that day's NAV.
- Unit accumulation: If NAV is Rs 100 in Month 1, you get 50 units. If NAV falls to Rs 80 in Month 3, you get 62.5 units for the same Rs 5,000. More units when price is low.
- Portfolio growth: As NAV rises over years, the value of accumulated units increases, building your corpus.
Rupee Cost Averaging in Action
| Month | SIP Amount | NAV | Units Bought |
|---|---|---|---|
| January | Rs 5,000 | Rs 100 | 50.00 |
| February | Rs 5,000 | Rs 90 | 55.56 |
| March | Rs 5,000 | Rs 110 | 45.45 |
| April | Rs 5,000 | Rs 95 | 52.63 |
| Total | Rs 20,000 | Avg ~Rs 98.7 | 203.64 |
Average NAV paid: Rs 20,000 / 203.64 units = Rs 98.21 per unit (less than simple average of Rs 98.75).
Impact of Market Downturns on SIP
One of the most powerful aspects of SIP is that market downturns actually benefit long-term SIP investors. When NAV falls, each monthly SIP buys more units at lower prices. When markets recover, the extra units bought during the downturn generate additional returns. Investors who stop SIP during crashes lose this advantage; those who continue (or increase) their SIP during crashes typically see excellent returns when markets recover.
When Does SIP Stop Working?
SIP works best over long periods (5+ years) in quality equity funds. It is less effective when:
- The investment horizon is too short (less than 3 years for equity SIPs).
- The fund selected consistently underperforms its benchmark.
- The investor stops SIP during market downturns (the worst time to stop).
Key Takeaway
SIP works through consistent monthly investment, rupee cost averaging, and the power of compounding over time. The key is staying disciplined: never stop a SIP during a market downturn. Use the Lemonn app to monitor your SIP performance, track unit accumulation, and stay committed to your long-term wealth-building journey.
