why to prefer step-up sip over a traditional sip?

systematic investment planning (sip) is one of the best ways to create long term wealth. for those who want to reap the benefits of rupee cost averaging and cut down the costs of their holdings over a long period of time, sip has proven to be one of the most effective financial vehicles.

while sip is quite popular amongst investors, a step-up sip is a step-up from the traditional investment. both sip and step-up sip are the same, with the minute difference that the monthly contribution increases every year during the sip tenure at a fixed percentage or by a fixed sum.

it is like an automated facility that allows the investor to increase their sip at periodic intervals, which aligns with the financial goals and income level. it is possible to arrive at sips using a sip calculator.

why step-up sip over traditional sip?

the value of money erodes over time which is called inflation. step-up sip includes inflation and helps the investor gain wealth keeping this in view. following are some of the advantages of a step-up sip over a traditional sip: 

• step-up sip builds a sense of financial discipline to maximise wealth. as a person’s income increases, he is motivated to invest more in savings for the future rather than spend the increased income.
  
• investments have to be increased over time, as a rule. a step-up sip paints a much more realistic picture of the increased income levels and invests money accordingly.
  
• step-up sip helps to focus financial planning on a few selected funds instead of investing in a group of funds that may become difficult to manage.

does step-up sip perform better?

step-up sip helps an investor to reach their financial goals sooner as it incorporates the power of compounding. an investor may become complacent and not think of voluntarily increasing their sip, as most people do not integrate their income growth with their investment plan. step-up sip automatically facilitates to factor this in and helps create a long-term corpus.

for example, an investor is looking to build a corpus for his child’s higher education and requires rs.15 lakhs after 10 years. however, the purchasing power of rs.15 lakhs will go down after 10 years, which means that the investor will need more than rs.15 lakhs to meet the higher education needs.

in such a scenario, it makes sense to incorporate the increased inflation rate into the step-up sip. suppose the inflation rate is 8%. one can calculate the actual returns using a mutual fund sip calculator.

traditional sip:

sip return: 15%

sip: ₹5,500 for 10 years

wealth built: ₹15.32 lakhs

step-up sip:

sip return: 15%

starting sip: ₹5,500

growth in sip every year: 8%

wealth built ₹20.23 lakhs

by increasing the monthly contribution in sip by 8% every year, there comes an increase in overall wealth built by 32%.

while a traditional sip is a good option to invest in, a step-up sip is inbuilt to tackle inflation and thereby generate returns for the investor in accordance with the growth rate. a sip return calculator can be used to arrive at actual returns. however, this is assuming the income of the investor is always growing upwards. if the income does not grow for some reason, but the sip amount keeps increasing year on year, it leaves the investor with little disposable income.