Inflation can be a significant roadblock in a long-term savings plan. Inflation rates in the economy often outpace the return on investments in traditional savings instruments such as fixed deposits or provident funds.
Inflation is the rise in the prices of goods and services over time. In effect, inflation reduces the purchasing power of your money. So, if you set money aside for 10 years in a traditional savings instrument and the tax-adjusted returns you earn on it are lower than the inflation rate in the economy over that period, it means that in real terms, you have lost money on your investments. Historical data shows that returns on such investments have rarely beaten inflation rates.
One asset class that has consistently shown the potential to beat inflation in the long term is equity. However, unlike FDs and provident funds, equity investments come with significant risk related to market fluctuation, which can affect your returns as well as the safety of your capital.
This is where Systematic Investment Plans or SIPs come in. By making investments affordable and convenient while potentially mitigating risk, SIPs can make equity investments more accessible to investors, thereby enabling them to achieve inflation-beating returns in the long-run.
Here are advantages offered by SIPs:
1) Make mutual fund investments more accessible: The risk of volatility and fluctuations in the value of underlying assets make conservative investors wary of the financial market. Mutal funds, through diversification and by pooling investor money, aim to capitalize on the opportunities presented by the market while mitigating risks and enabling investors to access a diverse portfolio even with a small capital. SIPs enable investors to set aside sums of money – starting at just Rs 500 – in regular instalments. Over time, these investments have the potential to build wealth. The SIP calculator on the website of Bajaj Finserv Asset Management Company can give you an idea of how even small but regular instalments can potentially add up to a substantial sum over time.
2) Risk mitigation through rupee cost averaging: When you invest via SIPs, you put in a fixed amount of money regularly regardless of the prevailing market condition. As a result, you end up buying more units of a scheme when the market is down (thereby lowering the mutual fund portfolio’s Net Asset Value or NAV) and fewer units when the NAV is high. Over time, this can reduce the average per-unit price, thereby putting you in a position to earn higher potential gains. This is known as rupee-cost averaging. This phenomenon saves you the trouble of trying to time the market to potentially capitalize on an undervalued asset or reduce your exposure to overvalued securities.
3) Power of compounding: When you invest in a mutual fund scheme, the earnings generated over a certain period are added to the principal amount for the next period. This increases the effective principal amount for the next returns cycle. So, you generate returns on your returns and over time, this has the potential to build a substantial corpus. The power of compounding is most effective over the long-term. To better understand the power of compounding, you can use the compounding calculator on the website of Bajaj Finserv Asset Management Company.
4) Benefit of diversification: Mutual funds give you access to a wide basket of assets and securities, allowing you to choose a scheme based on your investment horizon and risk appetite. For instance, investors who do not have a high risk-appetite can choose schemes that combine moderate or low-risk debt instruments with equity to provide relative stability as well as the potential to earn good returns. This allows even risk-averse investors potentially tap into the inflation-beating return potential of equity.
5) Via the top-up facility: Investors can give their strategy an additional boost by opting for the SIP top-up facility while starting an investment. Through this provision, you can increase your SIP instalment size by a fixed amount every year. For instance, you can increase it by 10% if that’s your average annual salary hike or choose an amount that is line with the typical inflation rate. Combined with the power of compounding, such a strategy can potentially be an even more effective way for your investments to outpace inflation. You can use the SIP top-up calculator to get an estimate of how an SIP top-up can potentially benefit your investment strategy.
By making mutual fund investments convenient and affordable, SIPs can help investors – even those who do not have financial expertise – to invest in the financial market and in asset classes that have the potential to offer returns that surpass inflation rates.
About Bajaj Finserv Asset Management Ltd.
Bajaj Finserv Asset Management Limited, a wholly-owned subsidiary of Bajaj Finserv Limited, has entered the investment solutions industry. Backed by one of India’s most respected and oldest brands, it offers a host of innovative products and solutions to every Indian. With a future-focused and differentiated investment strategy, its ambition is to help every Indian achieve his/her financial goals.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
