Do you remember when your parents told you to start saving as soon as you got your first job? Like most people, you may not have realized the importance of this at that time. If you still have not started, it is never too late to commence saving. In this article, we will talk about Recurring Deposit, RD disadvantages, What are advantages of SiP, RD vs SIP.
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Recurring Deposit
Today, there are a plethora of investment options available to help you save for a secure tomorrow. With the advancement in technology, investing has become extremely easy. You may get everything done—from learning about the various options available to invest in the same—from your smartphone or laptop. The commonest and most popular investment mechanism used since several decades are the small savings. You put aside a small amount at a periodic interval, which may be a week, month, or quarter.
This habit of regularly saving a small amount is the basis for Recurring Deposit (RD), wherein you make fixed deposits periodically. It inculcated investment discipline and patience and perseverance of waiting in long queues. Times are no longer like the good old days and you need to explore alternative investment options.
Reserve Bank of India (RBI) has adopted an accommodative monetary policy. As a result, the interest rates have decreased. However, inflation continues to rise and effectively erodes your purchasing power. Therefore, it is important that you find alternative avenues to achieve financial security and stability in the future. In addition to lower interest rates, here are three more disadvantages of an RD:
- Liquidity
You cannot withdraw any part of the money until the term of the deposit is over. If you prematurely terminate an RD, you will lose the interest and may have to pay a penalty for doing so.
- Lower interest rate
The interest rate is lower than that available on regular fixed deposits (FDs). This is because you invest a lower amount regularly in an RD. On the other hand, you invest a higher lump sum in a regular FD.
- Fixed investment amount
Once you decide on the RD amount, you are unable to change it for the entire duration. Therefore, being unable to pay this amount in a particular period due to a difficult financial situation is a big concern.
Systematic Investment Plan (SIP)
All the aforementioned limitations of an RD are overcome in a Systematic Investment Plan (SIP) made in mutual fund schemes. Learning how to invest in mutual funds SIPs allows you to create wealth over the long-term. These schemes are professionally managed and allow diversification of your portfolio. As several investors invest in such schemes, you are benefited from economies of scale. Here are five benefits of SIP investment:
- Flexibility
You may invest any amount that is convenient at periodic intervals. A daily SIP is also available to manage the volatility of the equity markets. This flexibility is not available in an RD.
- Cost averaging
When you choose a mutual fund SIP, timing the market becomes irrelevant. You are able to accumulate more units when the prices are lower and vice versa. Therefore, you are able to average the effective cost of your investments.
- Compounding effect
A regular SIP will grow into a large corpus over a longer period of time. The power of compounding plays an important role here. This feature enables you to earn income on your returns, which helps in wealth creation. Compounding is not available when you choose an RD.
- Liquidity
SIPs are highly liquid. This means that you may discontinue the SIP at any point. You may also partially or completely withdraw the amount invested in a mutual fund SIP. Furthermore, if you discontinue your SIP payments and do not withdraw the funds, your investments continue earning returns.
- Tax benefits
If the SIP is made in Equity Linked Savings Schemes (ELSS) or if you stay invested for at least a year in equity mutual funds, then the returns on the same are tax free. These tax benefits are unavailable in an RD. If the SIP is made on a debt mutual fund scheme and if you stay invested for at least three years, you enjoy an indexation benefit and the Long-Term Capital Gain (LTCG) tax is applicable. In case the holding period is less than three years, the tax levied will be as per your tax slab.
RD vs SIP: Comparing RD with SIP
Although RD and SIP both help to develop a disciplined investment approach, the latter provides several benefits. SIPs help in long-term financial growth while offering tax benefits.
| Factors | Recurring Deposit (RD) | Systematic Investment Plan (SIP) |
| Investment Scheme | In RD scheme, you will have to invest in a deposit plan that will give you a fixed rate of returns. It is debt part of your portfolio. | In a SIP of mutual funds, you can choose between debt or equity type of funds depending on your risk capability. |
| Risk Factor | Recurring Deposits are not prone to risks and is one of the safest forms of investment. | Returns that you can expect from the SIP are variable. There can be a risk of capital and returns depending on the stock market. But, recent data shows us the SIP gives good returns if held for a long period of time. |
| Investment Type | In a Recurring deposit scheme, the investor has to deposit a fixed amount every month. | Systematic Investment Plan is a way to put your money on mutual funds. Investment can be done on a periodic basis – daily, weekly, monthly or quarterly. |
| Returns | As the rate of interest is fixed in a recurring deposit scheme, the return is also fixed and known at the time of investment. | The returns from a SIP for mutual funds is dependent on debt and equity markets and is also based on the fund scheme chosen by the investor. |
| Liquidity | Recurring Deposit is liquid but premature withdrawal or closure will attract penalty charges. | In terms of liquidity, a SIP is better when compared to RD. SIP can be closed and the money can be withdrawn without any penal charges. |
Indians are investing in Mutual Funds through SIP
SIPs have been the preferred route for retail investors to invest in mutual funds as it helps them reduce market timing risk. Indian Mutual Funds have currently about 1.73 crore (17.3 million) SIP accounts through which investors regularly invest in Indian Mutual Fund schemes.
AMFI data shows that the MF industry had added about 8.86 lacs SIP accounts each month on an average during the FY 2017-18, with an average SIP size of about ₹3,250 per SIP account. The month-wise amount collected during FY 17-18 is as mentioned below :
| Month | SIP Contribution ₹ core |
|---|---|
| Apr’17- Oct’ 17 | 34,887 |
| Oct’ 17 | 5,621 |
| Sep’ 17 | 5,516 |
| Aug’ 17 | 5,206 |
| Jul’ 17 | 4,947 |
| Jun’ 17 | 4,744 |
| May 17 | 4,584 |
| Apr’ 17 | 4,269 |
How to Start a SiP
- Step 1: Get necessary documents.
- Step 2: Become a KYC compliant.
- Step 3: Start the SIP online.
Go ahead and take the risk of investing in these high-growth mutual funds and enjoy numerous benefits of SIP investment.
