SIP or FD - Which One You Should Choose?

Choosing between SIP and FD can be confusing, as both have different financial purposes. While Fixed Deposits can help earn guaranteed returns with low risk, Systematic Investment Plans enable you to invest in mutual funds gradually while helping you earn potentially greater returns over a longer period.

The main difference between SIP and fixed deposits is their returns, risks, liquidity, and tax treatment. This article will discuss key differences, benefits, return calculations, and when to use either of the two systems to help you decide which option will work best, depending on your financial situation.

A Systematic Investment Plan (SIP) is a way to invest in mutual funds over a period of time. It involves investing a set amount periodically, such as monthly or quarterly, and is not a one-time investment. SIPs allow investors to invest over time, helping to build wealth and enhancing market volatility through mean-variance analysis, known as rupee cost averaging.

With this methodology, you can buy more units when prices are low and fewer when prices are high, averaging your unit purchase price. SIPs are flexible, have low paperwork, are easy to follow, and provide financial discipline, making them a good investment vehicle for novice and experienced investors in a structured manner.

FD stands for Fixed Deposit, a well-known investment product by banks and financial institutions. With an FD, you deposit a lump sum amount for a fixed tenure, lasting from a few days to several years. The interest rate of an FD is fixed, so you are guaranteed an income irrespective of the market situation.

Upon the tenure's expiry, you will receive your capital plus the generated interest. FDs are characterised by safety, stability, and choice of length, therefore appealing to conservative investors who need assured returns and protected capital.

Calculating SIP (Systematic Investment Plan) returns involves understanding how your regular investments grow over time with compounding. The most widely used method is the future value formula, which estimates the total value of your SIP at maturity, assuming a constant rate of return.

Formula to calculate SIP:

The standard formula used is:

FV = P (1+ i)^n - 1/i * (1 + i)

Where,

• FV - Future Value (maturity amount)
• P - SIP amount invested every month
• I - Periodic interest rate (annual rate divided by 12)
• n - Total number of SIP instalments (months)

Example of SIP:

Suppose you invest ₹1,000 per month for 12 months at an annual return of 12%:

FV=  1000 (1+ 0.01)12 - 1/0.01 * (1 + 0.01) = 12,809

This means your total investment of ₹12,000 grows to about ₹12,809 in one year at a 12% annual return, compounded monthly.

Calculating FD (Fixed Deposit) returns is more straightforward because the interest rate is fixed and guaranteed.

Formula to Calculate FD:

For most FDs (especially cumulative FDs), the compound interest formula is used:

A =  P * (1 + r/n)^nt

Where,

• A - Maturity amount
• P - Principal (initial deposit)
• r - Annual interest rate (in decimal)
• n - Number of compounding periods per year (e.g., 4 for quarterly)
• t - Tenure in years

Example of FD:

If you invest ₹1,00,000 at 7% annual interest compounded quarterly for 5 years:

A =  1,00,000 * (1 + 0.07/4)^4*5 = 1,41,330

The calculation shows how a ₹1,00,000 Fixed Deposit (FD) grows to ₹1,41,330 over 5 years at a 7% annual interest rate, compounded quarterly.

Choosing between the two depends on your investment objectives, risk tolerance, and investment horizon.

• FDs may be suitable for conservative investors who prioritise capital preservation and a stable return on their investment. They are a safe and stable investment, but the value of the return may not always protect against inflation, decreasing long-term purchasing power.
• SIP allows the investor to regularly invest in a mutual fund. The returns build on those generated in prior years through the power of compounding and rupee cost averaging. SIPs have the potential for higher returns. However, they are subject to market movements and do not guarantee returns.
• Investors may choose an FD because it provides a stable investment and fixed returns, whereas long-term objectives may contain risk or potential loss. Investors may choose an SIP for long-term objectives, providing greater growth due to the same market risk as the FDs.

When it comes to SIP vs FD, there’s no fixed answer. Each serves a distinct purpose in your financial journey. Fixed Deposits are perfect for safety and guaranteed returns. SIPs, on the other hand, are ideal for long-term wealth creation, offering flexibility and the power of compounding through market exposure. The smart move is the one that aligns with your choice, financial goals, investment horizon, and risk tolerance.

Disclaimer: The information provided on this website is for general informational purposes only and should not be construed as financial, investment, or legal advice. While we strive to provide accurate and up-to-date content, we do not guarantee the completeness, reliability, or suitability of the information for your specific needs.

We do not promote or endorse any financial product or service mentioned in these articles. Readers are advised to conduct their own research, consult with financial experts, and make informed decisions based on their unique financial circumstances. Any reliance you place on the information provided here is strictly at your own risk.