SIP in Mutual Funds: How It Works and What Investors Get Wrong

Every SIP instalment buys units at that day's NAV. When NAV is lower, the same amount buys more units. When NAV is higher, it buys fewer. Over time, the average cost per unit tends to be lower than the average NAV over the same period, because more units are purchased during lower-price periods.

Here is what this looks like in practice over four months:

Total invested: Rs 20,000. Total units: 213.51. Average cost per unit: Rs 93.67. Average NAV over the period: Rs 95.00. The average cost is lower than the average price because more units were bought when prices were lower.

Rupee cost averaging does not guarantee gains or protect against loss. If the NAV at redemption is below Rs 93.67, the SIP will still show a loss. What it does is reduce the risk of having invested everything at a market peak.

This comparison is often presented as a contest where one wins. It is more useful to think of them as appropriate for different situations.

Neither guarantees better returns. A lump sum in a rising market outperforms SIP. A SIP entering a falling market outperforms a lump sum that deployed everything at the peak. Since markets cannot be predicted consistently, the practical choice is often determined by cash availability, not by which method theoretically outperforms.

Regular SIP

Fixed amount at fixed intervals. The most common type. Simple to set up and maintain.

Top-up SIP

The monthly contribution increases by a fixed amount or percentage at defined intervals, typically annually. A Rs 5,000 SIP with a 10% annual step-up becomes Rs 5,500 in year two, Rs 6,050 in year three, and so on. Over a decade, this compounds the corpus significantly more than a flat SIP at the same starting amount.

Flexible SIP

Allows varying the instalment amount based on cash flow. Useful for investors with irregular income. Less common than regular SIP.

Perpetual SIP

Continues without a predefined end date until you actively stop it. Useful for long-term investors who do not want to manage renewal.

SIP returns are measured using XIRR. Unlike a simple return calculation, XIRR accounts for the timing of each cash flow, since different instalments are invested at different points in time and earn returns for different durations.

For example: Rs 5,000 invested monthly for 10 years = Rs 6,00,000 total investment. If the portfolio value at end of year 10 is Rs 11,50,000, the XIRR is approximately 13-14% annually. This is not the same as saying each instalment earned 13-14%. It is a single annualised return figure that accounts for all the varying entry points and holding periods.

Many SIP calculators show projected values. These assume a constant annual return for the entire period. Markets do not deliver constant returns. The calculator output is an illustration, not a forecast.

This is the most practically important aspect of SIP taxation that investors miss.

Each SIP instalment is treated as an independent investment with its own purchase date. When you redeem, the holding period for tax purposes is calculated separately for each instalment under FIFO (oldest units first).

For an equity fund SIP running for 3 years, if you redeem everything in month 37:

• Instalments from months 1 to 24 have been held for more than 12 months. These qualify as long-term capital gains (LTCG) at 12.5% above Rs 1.25 lakh annual exemption.

• Instalments from months 25 to 36 have been held for less than 12 months. These are short-term capital gains (STCG) taxed at 20%.

This split applies to every full redemption of a long-running equity SIP and affects the actual post-tax outcome. For debt funds (post April 2023 investments), all instalments are taxed at slab rate regardless of holding period.

SIP is a useful mechanism, but several common beliefs about it are wrong:

SIP does not eliminate market risk

SIP spreads the timing of investment but does not protect against falling markets. If the NAV at redemption is lower than your average purchase cost, you will have a loss regardless of how long the SIP ran.

Stopping a SIP during a market fall is usually counterproductive

When markets fall, each SIP instalment buys more units at lower prices. Stopping the SIP removes precisely the benefit that makes rupee cost averaging work. Existing units remain invested and continue to reflect market performance. Stopping the SIP just means fewer low-price units are accumulated during the correction.

SIP does not mean you should ignore the underlying fund

The discipline of SIP is valuable only if the fund itself is suitable. A SIP into a consistently underperforming fund is still a bad investment. The mechanism does not rescue poor fund selection.

SIP investments are available across equity, debt, hybrid, and index fund schemes on the DSP Mutual Fund schemes page. To start a SIP, log in or create an account on the DSP Invest portal, select a scheme, choose SIP, set the amount and date, and register a bank mandate (eNACH or OTM) for auto-debit. Minimum SIP amount is Rs 100 per month.