5 things to know before starting your first SIP

Must know things about SIP: Systematic Investment Plans (SIPs) have become a popular way for individuals to enter the world of mutual funds. India is home to one of the biggest mutual fund investor populations and the AUM of the Indian mutual fund Industry has grown from Rs 10.11 lakh crore as of May 31, 2014, to Rs 58.91 lakh crore as of May 31, 2024, around 6 fold increase in 10 years.

SIPs offer a disciplined and flexible approach to investing, allowing investors to contribute a fixed amount regularly, typically monthly, into mutual funds. Before you start your first SIP, it is crucial to understand certain aspects to make informed decisions and optimise your investment returns.

Understand the basics of SIPs

Before diving into SIPs, it is essential to grasp their fundamental concept. A SIP allows you to invest a predetermined amount at regular intervals in a mutual fund scheme of your choice. 

This method leverages the power of compounding and rupee cost averaging, making it an attractive option for both novice and experienced investors. By investing regularly, you can buy more units when prices are low and fewer units when prices are high, thereby averaging the cost of your investments over time.

Know your financial goals

Identifying your financial goals is a critical step before starting any investment, including SIPs. Are you saving for a long-term goal like retirement, or your child's education, or a short-term goal like buying a car or taking a vacation? 

Understanding your goals will help you choose the right mutual fund schemes that align with your investment horizon and risk tolerance. For instance, equity mutual funds are better suited for long-term goals due to their potential for higher returns, while debt mutual funds may be preferable for short-term goals owing to their stability.

Assess your risk appetite

Different mutual fund schemes come with varying levels of risk. Equity mutual funds, which invest in stocks, are inherently riskier but offer higher potential returns. On the other hand, debt mutual funds, which invest in bonds and other fixed-income instruments, are relatively safer but typically yield lower returns. 

It is crucial to assess your risk appetite before choosing a mutual fund scheme for your SIP. If you are risk-averse, you might prefer debt funds or balanced funds, which offer a mix of equity and debt. Conversely, if you have a higher risk tolerance, you might opt for equity funds.

Evaluate the fund's performance

While past performance does not guarantee future results, it can provide insights into how a mutual fund has managed market fluctuations over time. Examine the fund's performance over different time frames—1 year, 3 years, 5 years, and since inception. 

Compare it with the benchmark index and peer funds. A consistent track record of outperforming the benchmark and peers is a positive indicator. Additionally, consider the fund manager’s experience and the investment strategy employed. This evaluation can help you choose a fund that aligns with your investment objectives.

Understand the costs involved

Investing in mutual funds via SIPs involves certain costs, which can impact your overall returns. The primary costs to consider are the expense ratio and exit load. The expense ratio is the annual fee charged by the fund house for managing your investment and is expressed as a percentage of the fund's average assets under management. 

A lower expense ratio means more of your money is working for you. Exit load is a fee charged if you redeem your units within a specified period, typically 1 per cent for redemptions within one year. Be aware of these costs and choose funds with competitive expense ratios and exit loads to maximise your returns.