A SIP in debt mutual funds.

A Systematic Investment Plan (SIP) is a mode of investment in mutual funds that is often associated with equity mutual funds. But, have you heard of a SIP in debt funds? More often than not, investors either do not know that such an option exists or are not aware of the benefits of a debt fund SIP. Allow us to bring some clarity to this subject.

First, let us understand the basics of SIP. SIP is when you invest a fixed amount of money at pre-defined regular intervals in a mutual fund of your choice. The other mode of investment is the lumpsum mode, wherein you invest a large/small amount all at once. The benefits of SIP are underlined when you look at the investment from a market volatility point of view. It is in the nature of the market to be volatile because it is affected by a number of macro and micro-economic factors. This volatility tends to fluctuate the Net Asset Value (NAV), which is the per-unit value of your mutual fund scheme. For example, let us assume that the NAV of your scheme was Rs 120 yesterday and is Rs 100 today. You see a drop in the NAV and think of it as a good opportunity to buy units since a lower NAV will fetch you more units for the same amount of investment. You invest Rs 5000 and buy 50 units. But tomorrow, if the NAV drops further to Rs 50, it is a lost opportunity for you.

Here is where a SIP tides you over the volatility. Now instead of investing Rs 5000 all at once, had you invested Rs 500 over a period of 10 months, you would have been able to buy more units when the NAV was low and vice versa. This benefit is called rupee cost averaging (RCA). Apart from RCA, SIP in mutual funds also helps you in regularizing your investments.

A logical question here can be that on one hand when we say that debt funds are less volatile, why do we need SIP in debt funds to tide over volatility?

Although a valid question, it disregards the fact that debt funds investment is prone to volatility as well; it is just relatively lesser than equity mutual funds. Also, it is relevant to note here that debt funds investment is not risk-free. It suffers from interest rate risk, which refers to the fluctuation in interest rates which directly impacts the bond price in the market. Hence, RCA, as a principle, will be very well applicable here too. You read more about the risks associated with debt funds

With lumpsum investments, there is a need to time the market, which regular investors may not have the expertise of doing.

In addition to all the above, SIP in debt funds can also help in harnessing the power of compounding. Since mutual fund investments work on the principle of compound interest, longer your money stays invested, a relatively better return you can get. With SIP instalments, the power of compounding helps you in maximizing the benefits of compound interest because of the investment being spread out in nature.

1. When calculating the capital gains, bear in mind that each SIP instalment is treated separately for calculation of the holding period. For other than equity-oriented funds, if your investment horizon is less than 36 months, and you redeem the money, your gain will be liable for short-term capital gains tax. If you redeem after 36 months, your gain will be liable for long-term capital gains tax. Taking the same example forward, if you invested in a debt fund via SIP in Jan’21, and redeem in Feb’24, only your first two instalments will be liable for long-term capital gain tax and the remaining for short term capital gain tax.

2. SIP is only the mode of investing in mutual funds, and there aren’t really any best debt funds for SIP. Your returns will depend on how well you match your risk appetite, goals and investment horizon to the mutual funds that you select. That is always the first step before deciding the mode of investing.

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