SIP Vs RD: Which Is A Better Investment Option
The key to successful investing is discipline, strategy, and comprehensive research. Disciplined investing is an ideology all investors would benefit from, adding to their portfolios. Retail investors need to streamline savings and build a well-rounded portfolio. This requires a strategic approach - one that is consistent and delivers!
Two common routes for disciplined investments are the Systematic Investment Plan (SIP) and Recurring Deposit (RD). These tools are popular for building wealth over time through regular investing habits.
In this article we will be discussing the two routes, their advantages, disadvantages and which one could be a better suited option for you.
In the past, a majority of Indian household savings were held as either savings accounts or fixed deposits. However, this has changed in the recent past.
An increasing number of people are switching to other forms of investments, boosting overall investor confidence. Investments in mutual funds by retail investors have grown at a rapid rate in 2024 compared to the past. There is a visibly rising trend in SIPs, as can be seen in the graph below:
What Is SIP Investment?
A systematic investment plan (SIP) is a facility provided by mutual funds where investors can invest fixed amounts regularly. The investment can be made monthly, quarterly, or weekly, depending on their convenience, instead of investing the whole amount together. This method of investing is becoming increasingly popular due to its attached benefit of building wealth over a long period.
SIP investments have been trending for several years, primarily due to the ease and accessibility they bring in!
How To Start A SIP Investment?
Investors can start with small amounts and reap rewards with this systematic investment form.
Advantages Of SIP
Rupee Cost Average (RCA):
RCA is an associated advantage of SIPs that allows averaging out investment costs across multiple periods. This automatically allots more units to the investor when the Net Asset Value (NAV) is low and fewer units when the NAV is high.
This can be understood using an example.
Suppose Investor A wants to invest INR 1200 in a mutual fund for 6 months. Investing through SIPs of INR INR 200 each regularly paid for 6 months, will help average the differences in NAV across each period.
Here’s how this happens:
Month | Invested amount (fixed amount each month) In INR | NAV of the fund (fluctuating) In INR | No. of units allotted = (Invested amount/ NAV) | Cumulative units allotted | Total Investment value = (Cumulative units*Current NAV) In INR |
0 | 200 | 20 | 10 | 10 | 200 |
1 | 200 | 17 | 11.76 | 21.76 | 370 |
2 | 200 | 21 | 9.52 | 31.28 | 656.9 |
3 | 200 | 20 | 10 | 41.28 | 825.6 |
4 | 200 | 18 | 11.11 | 52.39 | 943.0 |
5 | 200 | 18 | 11.11 | 63.5 | 1143.0 |
6 | 200 | 20 | 10 | 73.5 | 1470.0 |
Investor A can average out the cost of investment by using the SIP method. In periods of low NAV, the person is allotted more units of the fund, maximising the benefits of timing the trade. When the NAV is high, fewer units are purchased to average out the high cost.
- Organised Investment Approach:
Investing in SIPs is an organised and disciplined form of investment. It sets a routine investment lane for investors to walk on.This inculcates the habit of disciplined investing, often crucial for long-term investment success.
- Cost-Effective:
SIP investments are considered a cost-effective investment option available in mutual funds. It offers low initial investment options and helps in gradually building an enhanced portfolio.
- Compounding Benefits:
Compounding provides investors using SIPs to grow their investment corpus exponentially rather than linearly. The invested amount can grow manifold in a long-term investment period. The power of compounding is an added advantage of SIPs.
Disadvantages Of SIPs
- Market Dynamics:
SIPs are characterised by their inability to perform well when the market is consistently rising. This is because, with a fixed amount of investment each month, the number of units purchased would consistently go down. This forbids the investors from earning a good return on their future investments.
- Lock-In Period:
Some SIPs have a specific lock-in period for investors during which one cannot withdraw their units. This is especially the case in tax saver mutual funds, where money is typically locked in for three years.
- Lower Returns In The Short Term:
SIPs are suitable for long-term investors as the rules of compounding can work properly over longer periods of time.There is no such advantage in the short term.
- Loss Of Possible Gains:
While SIPs do come with the advantage of averaging out costs across market dynamics, they may not always be able to encash the peaks of the market.
What Is RD?
A recurring deposit is an investment option that allows a regular fixed amount of deposits while earning interest on them. The maturity of these deposits ranges between short to long term.
RD offers a fixed interest rate on investments each chosen period until the maturity. RD is offered by banks, financial institutions, and post offices in India, with options for flexible tenure.
Investors can begin investing with minimum amounts over a chosen period, enabling wealth generation over the long term.
Advantages of RD
- Ensures Regular Savings:
Investing in RD promotes a regular investing habit, leading to an organised investment approach.
- Attractive Interest Rates:
This form of investment generally offers a relatively higher rate of interest than a regular savings account. Investors are, therefore, motivated to invest in RDs.
- Flexible Tenures: The tenure of RD can either be short, medium or long-term depending on investor preferences.
Disadvantages Of RD
- Does Not Account For Inflation:
A fixed rate of interest for the entire term of the RD does not account for changes in inflation and therefore is a disadvantage for investors investing in the long term.
- Lower Returns Compared To Other Forms Of Investment:
Despite a higher interest rate than other forms of deposits, the return is still lower than most forms of investment like equity and mutual funds.
- Penalty On Premature Withdrawal:
Premature withdrawals can incur a penalty, lowering the total future return on the investment.
Differences Between RD And SIP
Feature | SIP | RD |
Type of investment | Requires a fixed sum to be invested in regular intervals that is invested into a mutual fund scheme potentially earning a return. | Requires a fixed sum to be invested in regular intervals that goes into a bank account earning interest. |
Return | Returns are not fixed, and depend on the performance of the fund. | Interest rates are fixed. |
Tenure | Do not have a specific tenure. | Has a predetermined tenure. |
Risk | A certain degree of risk exists, considering returns are dependent on fund performance | Risk is negligible, as the interest rate is fixed |
Taxation | Taxation is applicable on capital gains (Short term, Long term) once the units are sold | Tax Deducted at Source (TDS) is applicable on interest earned on the amount, as per the investor’s tax slab |
Liquidity | Better liquidity than RD as investors can enter and exit as required | Low to moderate, as premature withdrawals usually incur a penalty |
Similarities Between RD And SIP
- Both SIP and RD require making regular pre-determined payments in fixed intervals
- Both of these can be started with a low initial investment
- Both are ideally considered to be long-term in nature
- Both develop a savings habit- driving a disciplined investment approach
SIP Vs RD: Which Is A Better Investment Option?
With a similar investment pattern in place, investors are often confused between these two choices of investments. While RD guarantees a fixed rate of return, SIPs come with intrinsic market risk. Post the pandemic, there is a shift in household savings, with a reduced savings into deposits and higher savings into SIPs.
RDs are safer and more stable compared to SIPs. However, SIPs offer more flexibility, potentially higher long-term returns, and access to wider investment options.
An investor with a lower risk-tolerance, should choose RDs. Whereas, investors with low to moderate risk can choose SIPs.
Bottomline
Both RDs and SIPs are considered safe forms of investment due to their comparatively stable structure. The ultimate choice to invest in either depends on an investor’s risk tolerance, return expectations and financial goals.
SIPs offer the potential for growth in the long-term, along with their suitability for different risk-levels. For a long-term investor, SIPs do emerge as a better choice.
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Frequently Asked Questions On SIP And RD
1. What happens if I stop paying for RD?
Missing an instalment on the RD can incur penalties, charges, loss of interest, and account closure. A single instalment default incurs penalties. However, in case of consecutive failures, the bank could deactivate the account, leading to permanent damages along with charges incurred. This will, in turn, lead to lower financial benefits linked to your RD.
2. What is the minimum period for SIP?
SIPs do not have a fixed maturity. However, Asset Management Companies (AMCs) that launch mutual fund schemes often impose a minimum period of investing. This depends on the terms and conditions of the respective AMC. The investor needs to confirm the minimum period of investment with the chosen AMC before initiating the SIP.
3. Can I redeem my Recurring Deposit before the original term?
RD can be redeemed pre-maturely, by paying a penalty charge. Most banks allow premature withdrawals subject to their terms and conditions. Some banks allow premature withdrawal of the full amount, only once before maturity. There are rules applicable to these withdrawals, depending on the bank chosen by the investor.
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