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4 Reasons Why SIPping Into Mutual Funds Is Better Than RD - Outside View by PersonalFN
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4 Reasons Why SIPping Into Mutual Funds Is Better Than RD
May 10, 2017

Do you reminisce about visiting a post office or bank with your parents to deposit their savings / investible surplus every month into a recurring deposit?

Perhaps as you grew up and started earning, they might have even pestered you to subscribe to this regular investing habit.

But those were the good old days of saving regularly through banks and post office schemes, although it required patience and perseverance to stand in long queues. It even instilled the habit and discipline of saving and investing regularly for a healthy financial future.

However, times have changed and we need to move ahead with the times; so, explore other contemporary options to start saving.

As you know, with the advent of technology, investing has become easy - everything's available at just a click of your mouse and smartphone. But then, investing is a serious business. You got to adopt enough prudence in the interest of personal and familial financial wellbeing.

Deposit rates at banks have gone downhill as a result of RBI's accommodative monetary policy stance, and inflation effectually eroding the purchasing power of your hard-earned money.

You need to look for promising wealth creating investment avenues for a bright financial future, where you can accomplish many of your financial goals, viz. buying a dream, a car, providing the best education to your children, getting them married in style, travelling abroad for leisure, and living a blissful retirement, and so on.

Mutual funds are a promising investment avenue for long-term wealth creation. They offer advantages such as

  • Diversification;
  • Professional management;
  • Lower entry level;
  • Economies of scale; and
  • Liquidity

(Read: 5 Reasons Why You Should Invest In Equity Diversified Funds)

Moreover, today mutual fund houses provide innovative plans and services. There are two modes of investing: Systematic Investment Plans (SIPs); and Systematic Transfer Plans (STPs).

SIPs, like RDs, help you save and invest regularly in a disciplined, systematic manner. However, unlike RDs where you deposit a fixed sum of money every month with a bank / post office, your money is deployed in a mutual fund scheme (equity schemes and / or debt schemes) of a respective mutual fund house. SIPs are subject to market risk, while in RDs you earn a fixed rate of interest.

The question is, why would you opt for SIP over RDs?

A few reasons mentioned below will surely help you take an informed investment decision...

  1. Tax Benefits

    SIPs in mutual funds outscore RDs, if we consider the tax angle. In case of RDs, tax is deducted at source if interest income exceeds Rs 10,000. But that's not all. The interest income added to your 'return of total income' income as 'income from other sources', and the tax liability is determined as per one's tax slab.

    On the other hand, SIPs in mutual funds is far more efficient.

    When you invest in equity mutual funds and stay invested for period of at least 1 year, the capital gains earned, are tax free. If you sell the equity mutual fund units before a year, the gains will attract a short-term capital gain tax @15%.

    Likewise, when you invest in a debt mutual fund scheme vide a SIP and stay invested for holding period of at least 3 years, although the capital gain is taxable, you enjoy a indexation benefit (for inflation) and the Long Term Capital Gain (LTCG) tax payable is @20%. This is far better than paying tax as per your tax slab, particularly when you're in the highest tax bracket. However, in case of debt mutual fund schemes if the holding period is less than 3 years, the tax levied will be as per you tax slab.

    Having said, when you're planning for your long-term financial goals, SIPs in mutual funds are clearly advantageous - tax efficient!
  2. Better risk-return trade-off

    For the risk you take (which is a function of your age, income, expenses, assets & liabilities, investment horizon, and financial goals), SIPs in mutual funds can be a worthy option while you endeavor to achieve your financial goals.

    Take enough care to select winning mutual fund schemes for your portfolio and have a high risk appetite along with an investment horizon of at least 5 years. The average returns generated by diversified equity mutual funds in last 5 years are around 18% CAGR. Over the long-term SIPs power your portfolio with the benefit of compounding.

    If you need superlative and unbiased research-backed guidance to select the best equity mutual fund schemes for your portfolio, opt for PersonalFN's 'FundSelect' service. We will share with you The 6 ultimate secrets to beating the market by a whopping 70%! It is the simplest and potentially the best way to grow your portfolio value significantly!

    When you consider the tax angle and inflation, returns in RD are meagre. As a result achieving some of the vital financial goals in life can be a challenge. Most RDs give around 6.0%-7.5% interest per annum.

    If you need handholding while investing, don't hesitate to seek services of a Certified Financial Guardian who is a mark of trust and respect. They can help you construct a robust investment portfolio based on your asset allocation.
  3. Volatility

    As mutual funds invest in market-lined securities such as stocks and bonds, your investments are subject to market risk - there is a significant amount of volatility. But with SIPs, volatility can be mitigated due to rupee-cost averaging.

    Under rupee-cost averaging, you would typically buy more mutual fund units when prices are low, and similarly, buy fewer mutual units when prices are high. So, many a times SIPs work better as opposed to one-time or lump sum investments in mutual funds.

    Comparatively RDs, while they generate fixed returns and are not volatile, may not help you achieve your vital financial goals.
  4. Penalty

    Also, if you miss out on rendering your SIP payments for three consecutive months then your SIP mandate is terminated. There is no penalty charged. But whatever you've invested until then, will continue to earn you returns. Ideally, you should not stop SIPs.

    Today, mutual fund houses provide a facility to pause your SIP when you are financially under pressure. So, avail of this facility instead of stopping SIPs or waiting for the fund house to terminate the SIP mandate. Remember, it can hinder your path to wealth creation.

    On the other hand, if you miss out an instalment in RD in any particular month, usually a penalty would be levied. Moreover, if you wish to withdraw before maturity you will again attract some amount of penalty.

To Sum-up...

Recurring deposit and SIPs both inculcate discipline and regular investing habit. But for your long-term financial wellbeing, where you need tax efficient and effective inflation-adjusted returns, SIPs are certainly worth the risk of investing in mutual funds.

Remember, there are advantages of SIPs:

  • SIP effectively stops you from trying to time the market and inculcates financial discipline, plus a habit of saving and investing regularly.
  • There are lighter on your wallet. You don't need a large amount of money to start an SIP, you can start with as little as Rs. 500 per month, and slowly build up your wealth; and
  • SIPs are an effective medium of goal planning.

So, go ahead and take SIPs today!

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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1 Responses to "4 Reasons Why SIPping Into Mutual Funds Is Better Than RD"

chandra mohan

May 23, 2017

i have few comments:-
1.it is not clear whether we are comparing equity based or debt based SIPs with RD.to my knowledge no study is available where RD and debt based SIP have been compared over different market cycles.
2. tax status of the invester.
3.SIPs in flat/falling prolonged phases of stock markets.

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