SIP Vs Mutual Fund: Understanding the Key Differences

Investing can feel overwhelming - especially with so many investment options available. Mutual funds and systematic investment plan (SIP) are two commonly used terms in the investing world and often used interchangeably. But here’s the reality - SIP is a way to invest, while mutual funds are what you invest in. Think of mutual funds as the destination and SIP as the journey.  

Let’s look at what is a mutual fund and SIP and help you decide what is the best way to invest. 

A mutual fund is an investment scheme that pools money from various investors to invest in stocks, bonds, commodities, and other financial instruments. These funds are managed by professional fund managers who aim to maximize returns while managing risks for a small fee.

Types of Mutual Funds

Before investing, it’s essential to know the types of mutual funds available: 
 

• Equity Schemes: These funds allocate at least 65% of your investment to equities and equity-related assets, exposing you to higher market risks. They include small-cap, mid-cap, large-cap, and multi-cap funds.
• Debt Schemes: Such funds invest in fixed-income securities, providing more stable and predictable returns.
• Hybrid Schemes: Hybrid funds offer a balanced approach by allocating investments across equity and debt instruments. They can be categorized into aggressive hybrid funds, conservative hybrid funds, and balanced advantage funds, among others.
• Solution-Oriented Schemes: Designed to meet specific investment goals, these funds typically have a lock-in period of at least 5 years.
• Other Schemes: You can also go for index funds. For a low-cost, passively managed option, index funds replicate the performance of a specific market index. Similarly, exchange-traded funds (ETFs) are another investment option that trades like stocks.

You can invest in mutual funds in the following ways:

• Systematic Investment Plan or SIP
• Lump-Sum Investment

A SIP enables you to invest a fixed amount at regular intervals (often monthly) into a mutual fund (or even stocks or ETFs). Instead of investing a large sum at once, SIP allows you to stagger your investment, hence mitigating the risk of market volatility.  

When you start a SIP, the specified amount is automatically deducted from your bank account on a predetermined date and used to purchase mutual fund units at the current Net Asset Value (NAV). Because you invest regularly, you buy more units when prices are low and fewer units when prices are high – hence averaging your cost of purchase. SIPs are actually known for their advantage in rupee cost averaging, helping investors mitigate market volatility over time

Let’s understand this with an example. Imagine you start a SIP of ₹2,000 every month in a mutual fund from January 2025. 

Let’s break it down simply:

• In January, the NAV is ₹11.75, so ₹2,000 gets you 170.21 units.
• In February, the price increases to ₹12.50, meaning you get 160 units for ₹2,000.
• In March, the NAV drops to ₹10.52, so you buy 190 units.

After three months, the average buying price comes out to ₹11.54 per unit.

Investing consistently regardless of price fluctuations is what makes SIPs great for rupee cost averaging. 

It is easy to confuse SIP with a mutual fund.  Here is a quick breakdown of their dissimilarities:

1. Definition and Approach:  

• Mutual Fund: Imagine you want to invest in a basket of stocks, but you don't have the time or expertise to pick individual stocks. You decide to invest in a mutual fund, which pools money from many investors to buy a diversified portfolio of stocks, bonds, or other securities. The mutual fund is managed by professional fund managers who make investment decisions on your behalf.

• SIP: Now, let's say you want to invest in that mutual fund, but you don't have a large sum of money to invest all at once. Instead, you choose to invest a fixed small amount of money regularly (e.g., monthly) at a fixed date every month using SIP mode. This way, you can invest small amounts over time, making it easier to manage your finances and benefit from rupee cost averaging.

2. Investment Method:  

• Mutual Fund: Investors can choose between two methods to invest in mutual funds: a lump sum investment, which involves making a one-time contribution, ideal for those with surplus funds; or a Systematic Investment Plan (SIP), which enables regular, fixed contributions, promoting disciplined investing and benefiting from rupee cost averaging.

   

• SIP: SIP is a method of investing in mutual fund where  a fixed amount gets deducted from your account periodically to purchase units of chosen mutual fund at the market price. You need to ensure that your account has sufficient funds on the debit date.  

3. Flexibility and Convenience:

• Mutual Fund: Investors can choose between making a large upfront investment or opting for smaller, regular contributions, allowing for more flexibility and ease.

   

• SIP: It is ideal for small investors or those with a regular income stream. One can invest a fixed sum, weekly, monthly, or quarterly, and even pause or exit the plan during financial challenges.  

If you are looking to grow your wealth over time, investing in mutual funds through SIPs is a smart choice for these reasons:

• Disciplined approach to investing: SIP automates savings and ensures consistent investing since the amount is auto debited at each interval.
• Rupee cost averaging: It helps you buy more units when prices are low and fewer when prices are high, averaging your cost of investment.
• No need for market timing: Through SIPs, you invest regularly, regardless of market fluctuations. 

If you enjoy navigating the market's ups and downs and are prepared to take on higher risks, a lump sum investment in mutual funds might be the right choice for you. Here are the potential benefits:

• High returns during market growth: A lump-sum mutual fund investment can yield significant returns when the market upswings.
• Suitable for investors with surplus funds: It is also an excellent choice for those left with excess funds or irregular income. 

There is no clear winner, as both SIP and lump sum mutual fund investments have their positives and negatives. The decision between SIP and lump sum depends on:

• Risk appetite: While SIPs suit cautious investors as they help mitigate market volatility; lump-sum buying is better for risk-takers since these investments can outperform the SIPs if the market booms.
• Investment goals: Your financial objective whether it's retirement savings or child education, guides you select a suitable method of investing in mutual funds.
• Time horizon: SIPs are great for long-term goals, whereas lump-sum can work for both short and long-term needs. 

• Diversify Your Portfolio: Spread your investments across asset classes to manage risk.
• Regularly Monitor and Re-balance: Periodically review your portfolio to ensure it aligns with your financial goals.
• Choose Funds Aligned with Financial Goals: Opt for mutual fund schemes that match your risk tolerance limit and investment objectives. For instance, hybrid funds for retirement or equity funds for wealth creation. 

1. Can I invest in mutual funds without SIP?

Absolutely! Investment in mutual funds through SIP is not mandatory. You can choose a lump sum investment, where you deposit a large amount altogether.

For instance, if you have ₹75,000 in savings, you can invest the entire amount in a mutual fund scheme at once.

2. Is SIP safer than investing a lump sum?

Yes, SIPs carry less risk. They enable you to invest small amounts regularly and reduce the effect of market fluctuations through rupee-cost averaging. Through time, SIPs help build wealth gradually and steadily.

If you have a higher risk tolerance and a large sum of money to invest upfront, a lump sum investment will yield higher returns under favorable market conditions.

3. How much should I invest in SIP each month?

Most schemes have a minimum SIP requirement of ₹500, so you can begin with as low as ₹500 SIPs per month and you can go as high as you want. Ideally, the SIP amount depends on your financial goals, expenses, investment horizon and risk appetite.

For example, if you earn ₹1,00,000 per month, and are left with ₹30,000 after paying off all the expenses, you may decide to invest ₹20,000 in mutual fund schemes via SIP and save the rest ₹10,000 for your emergency funds.

4. What about taxes on SIPs and mutual funds?

When it comes to taxation, the same tax rates apply whether you invest in a mutual fund lump sum or through SIP. Your taxes depend upon the type of mutual fund that you hold:

a. Equity Mutual Funds:

• Long-term Capital Gains: Any gains above ₹1 lakh are subjected to LTCG tax @10% (with additional cess and surcharge). Below ₹1 lakh, LTCG is tax-free.
• Short-Term Gains: Gains within a year from mutual funds are taxed at 15% (with additional cess and surcharge). Say you gain ₹50,000 in six months; you will pay ₹7,500 as taxes.

b. Debt Funds:

Such funds are taxed based on slab rates, irrespective of the holding period (as per the Finance Act 2023). Dividend Distribution Tax (DDT) is no longer applicable, as dividends are taxed directly from the investors.

5. Can I stop or pause my SIP?

Yes, you can pause or stop your SIP at any point in time and redeem your investments. While processes and rules may vary depending on your investment platform, you always have the flexibility to discontinue your investment if needed.