How Is a Mutual Fund Different from a Systematic Investment Plan (SIP)?

Mutual Funds vs. Systematic Investment Plans (SIPs): An Overview

Mutual funds are often described as a basket of stocks or bonds managed by a professional with shares of the portfolio made available for purchase by investors. At the end of each trading day, all the fund’s holdings are priced and the fund’s net asset value is calculated. Purchases of mutual funds can be made with lump-sum investments or through a systematic investment plan (SIP). While a mutual fund is an investment product, a SIP is an investment plan that involves mutual funds.

Key Takeaways

• A systematic investment plan involves investing a consistent sum of money regularly, and usually into the same security, which could be a mutual fund or funds.
• A SIP generally pulls automatic withdrawals from the funding account and may require extended commitments from the investor.
• SIPs operate on the principle of dollar-cost averaging, buying more shares when prices dip.
• Most mutual fund companies offer SIPs.

Mutual Fund

Mutual funds are investment vehicles that pool money from many investors and then put that money to use following a stated strategy. They allow investors to get professional money management across a range of strategies and investment styles.

For example, one mutual fund may generate extra returns by identifying under-valued small-cap stocks with high growth potential by undertaking in-depth research while another mutual fund may passively replicate the S&P 500 index.

Investors should understand the costs associated with mutual funds. Fees are based on the type of mutual fund, investment strategy, and/or the managing company. For instance, funds may come with expense ratios, sales charges, maintenance fees, and redemption fees. some funds may also have minimum investment requirements, which means there may be high barriers to entry.

Funds may be actively or passively managed, where:

• Active funds take a hands-on approach. These try to beat the stock market or underlying index and are regularly rebalanced.
• Passive funds take a back-seat approach to investing. They try to replicate the returns of the underlying index.

Investors can choose from different types of mutual funds, including stock funds, bond funds, index funds, and money market funds to name a few. These categories can be further divided to give investors even more options, such as large-cap or blue-chip stock funds.

Important

Make sure you understand the risks involved with any investment you’re considering before you dive in. Doing your due diligence and research will help you minimize your losses.

Systematic Investment Plan (SIP)

A systematic investment plan is an investment plan where investors make regular, equal payments into a mutual fund, trading account, or retirement account such as a 401(k). You might set up a SIP to buy $100 per month worth of Mutual Fund A. The order is executed each month on the specified date. This way of investing offers two key advantages: easy saving and buying shares consistently even when the markets are down, which enables better prices on average.

Setting up a SIP makes it easier to budget for retirement and other investment goals. When you work a small amount into a monthly budget, it becomes more likely that you stick with the plan, making it easier to achieve your investment goals. For example, it is relatively easy to commit to investing $100 per month for retirement savings, but coming up with $1,200 at one time may be more difficult.

Making regular mutual fund share purchases lets you reduce the average cost per share. Market fluctuations over time are likely to present opportunities where shares are purchased at a lower price. This technique, called dollar-cost averaging, is a widely used strategy by many investors and is recommended by financial advisors

Advisor Insight

Dan Stewart, CFA®
Revere Asset Management, Dallas, TX

A systematic investment plan, or SIP, simply means making periodic and scheduled contributions to your investment account or a specific security. Dollar-cost averaging is a SIP in its simplest form.

For example, investing $500 per month total in two different mutual funds of $250 each would be a SIP. But a SIP is not an investment strategy like a mutual fund. A mutual fund is a professionally managed fund in which the manager invests according to the fund’s prospectus.

While the SIP is a great way to invest when growing your assets, once you accumulate a decent amount of wealth and are, say, nearing retirement, you may want to consider some type of defensive strategy that involves more active management.

Do I Pay a Fee If I Cash in my Mutual Fund Shares?

This depends on the mutual fund. You may have to pay a fee if you decide to cash in your mutual fund shares. This fee is called a redemption fee or an exit fee/load. If you don’t want to pay a fee, consider looking for no-load funds. These mutual funds won’t charge you for selling your shares.

What Types of Investments Can Be Used in a SIP?

Systemic investment plans can be used to invest in different types of assets. These include mutual funds and exchange-traded (ETFs). SIPs can also be used as investment vehicles for certain retirement plans, such as 401(k)s.

Are There Any Fees Associated with SIPs?

There may be fees associated with SIPs. These may include service fees and custodial fees. Investors should also look out for heavy account maintenance fees, sales charges, and high redemption fees. One of the reasons why SIPs tend to charge hefty fees is because it costs a lot to create and maintain them.

How Safe Are Mutual Funds?

Mutual funds are considered to be some of the safest investments for investors because they allow investors to diversify their holdings. They are not nearly as risky as other investments like stocks or bonds. Keep in mind, though, that they do come with some risk—notably, general market and inflation risk. You may lose some or all of your principal and may also be subject to high expense, management, and redemption fees.

The Bottom Line

Mutual funds are a very popular investment vehicle because they give investors a good way to diversify their holdings with little risk. Investors can use systemic investment plans, which can be used to invest in mutual funds, to execute their investment goals. Mutual funds and SIPs can be a great way to help you reach your investment goals. But, make sure you do your research to ensure that your investments align with your financial situation and goals so you don’t end up with major losses on your hands.