SIP – the recipe to build long-term wealth

A systematic investment plan (SIP) has emerged as a veritable method of generating wealth in the long run. It does not matter whether you are able to identify the tops and the bottoms of the market in the long run. What really matters is how you are able to take a disciplined approach to investing and invest in wealth creating equities in a consistent and regular manner.

First let us understand the five factors that will drive wealth creation through SIPs:

Start early even if you start small. Remember, even small investments can grow into big numbers if you stay invested for a longer period.

The earlier you start, the more your principal earns returns and the more your returns generate further returns. That is called the power of compound and is at the basis of the success of an SIP.
SIP is all about discipline. If you commit that you will invest Rs 5,000 each month in an equity fund, then the discipline is important. You must treat that SIP as a commitment and then build your family budget around that. Don’t skip an SIP once it is started.

Ensure that your SIP is invested in high return equities. That is the only way to create wealth in the long term. Even if you continue with your SIP on a liquid fund for 25 years you cannot generate substantial wealth over the longer term. You need the power of equities (it is actually low risk over a 20 year period) for the success of an SIP.
The beauty of the SIP is that it does not bother about timing the market. Market tops and bottoms are not your concern and nor are they relevant. Don’t try to reduce the SIP if markets go up or increase the SIP if markets go down. You are breaking your own discipline based on your judgement. Don’t time the market under any circumstances.
Make it a point to opt for the growth option of an equity fund when you start the SIP. When you opt for a dividend plan, the fund will pay the dividends to your bank account. Unless you reinvest the dividend at similar yields (which normally never happens) you are going to destroy your long term wealth. Also dividends are less tax efficient compared to capital gains. As a matter of principle, always opt for a growth plan of equity fund for long term wealth creation.

Term of SIP makes a big difference

There are two aspects to wealth creation through SIPs. The first is how early you start the SIP and the second is at what rate you allocate money to your SIP. The thumb rule is that the earlier you start the SIP, the better it is.

Let us see the importance of starting the SIP early by comparing the wealth created by four friends. Ajay starts the SIP of Rs 5,000 per month at the age of 25; Rajesh starts with Rs 10,000 per month at the age of 30; Vijay starts with Rs 15,000 per month at the age of 35; and Ram starts with Rs 20,000 per month at the age of 40. They all plan to retire at 55.

The table above clearly underlines the importance of starting early and staying invested for a longer period. If you compare, Ajay has made the lowest total investment over 30 years, yet, he has created the maximum wealth at the age of 55.

The difference is very stark when you compare the cases of Vijay and Ram.

Both invest the same amount in SIPs, just that Vijay starts 5 years earlier than Ram. But that means Vijay’s wealth at the age of 55 is nearly 50% higher than that of Ram.

The moral of the story is that if you want the SIP to create wealth then you need to focus on starting early, maintaining discipline and focusing on diversified equity funds. The rest will follow!

(The writer is CMO at Angel Broking)