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SIP vs RD – Which is the Better Investment ?

  • Rudri Rawell
  • Jan 12 2022
  • 7 minutes
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There are many investment avenues available in the market today that can help investors in wealth creation. Two such asset classes that assist in wealth creation in the long term are equities and debt instruments. With equity investment, investors can gain ownership in the company and debt instruments are considered as lending since the company owes the money to investors. Recurring deposits or RDs are term investments made by investors with banks. These have features similar to debt products, as the bank owes investors the principal amount combined with interest at maturity. Systematic investment plans or SIPs are a mechanism to invest in mutual funds. RDs and SIPs are meant for different investment objectives. Here, we will try to understand SIP Vs RDs – Which is better?

Choosing Between SIP Vs RDs

What is a recurring deposit (RD)?

A recurring deposit (RD) is an investment option where an investor has to deposit monthly instalments for a pre-defined period to earn fixed returns on the investment. RD interest rates are generally the same as on Fixed Deposits (FDs) for banks. It is one of the most risk-free investment schemes usually preferred by traditional investors.

RDs have a minimum investment duration of 6 months and the maximum tenure can be 10 years. RD returns are generally assured, with no market risk attached. Therefore, these make for a perfect investment option for short-term goals.

What are the benefits offered by recurring deposit investments?

Here are some of the benefits offered by recurring deposits/RDs:

  1. Guaranteed returns: Recurring deposit returns are fixed and guaranteed. Banks determine the interest rate on RDs and may change the same as per RBI guidelines. RD interest rates tend to remain the same throughout the investment tenure.
  2. Short investment tenure: RD is the right investment option for investors who wish to fulfil their short term financial goals through small monthly investments. 
  3. Easy to invest: Those who have a savings account with any scheduled commercial bank can easily open an RD account using the bank’s net banking facility. This investment does not require any additional documentation.

What is a Systematic Investment Plan (SIP)?

A systematic investment plan (SIP) is a mode of investing in mutual fund schemes. SIP allows investors to make small portions of investment at pre-defined intervals. Investors can decide on the frequency of instalments that can range from daily, monthly, to even annual options. Investors who want to earn high returns on investment and have higher risk tolerance can go for SIP investments to cater to their financial goals.

What are the benefits of investing in SIP?

Here are some of the benefits offered by SIP:

  1. Liquidity: Investment in mutual funds offers higher liquidity since investors can redeem their units as per their requirements. Many schemes do not apply any charges upon redemption. Thus, compared to recurring deposits, this investment option offers more liquidity since an investor has to pay a penalty for premature withdrawal from RD.
  2. Flexibility: Mutual fund SIPs allow investors higher flexibility since they can cancel the subscription at any point. Investors can also increase or decrease the SIP amount as per personal preference. 
  3. Compounding benefit: Mutual fund SIP returns can multiply because of the compounding effect. This allows investors to not only earn interest on the principal amount but also earn on the interest accrued over the principal. For example, if you invest Rs. 500 in a mutual fund SIP that has a 10% rate of return, the interest earned after a year would be Rs. 50. From the year after that, the interest earnings will be calculated at Rs. 550. Thus, one can benefit in the long run due to the compounding effect.

Which one to choose – Systematic Investment Plan(SIP) Vs Recurring Deposit (RD)?

While selecting between SIPs and RDs, investors can consider the below-mentioned points for better decision making:

Returns

RD returns are fixed, as per the interest rate communicated by the bank. Most RDs have the same interest rate as offered on Fixed Deposits (FDs). Returns from mutual fund SIPs are not fixed since these are linked to market movements. The returns could be high or low depending on how well the underlying securities of the portfolio perform. 

Risk

Since SIP returns are market-linked, an investor cannot be certain about gains or losses from this investment. If the market performs as per fund manager expectations, the returns can be high, else there are chances of losses too. Therefore, the risk attached to mutual fund SIPs is higher. This makes them a riskier investment option as compared to RDs, since the returns from the latter are guaranteed, as per the bank’s predetermined interest rate.

Investment frequency

An investor must invest in a Recurring Deposit (RD) every month, whereas the SIP frequency is as per the investor’s choice and can be daily, weekly, monthly, quarterly, semi-annually, or annually. Thus, there is higher flexibility in choosing investment frequency with SIP as compared to RD.

Investment horizon and goal

Whether one invests in a Recurring Deposit or a Systematic Investment Plan, the decision entirely depends on an investor’s investment objective and time horizon of investment. Those who have a shorter investment horizon, for example, 1 – 4 years, should opt for RD. If an investor wants to invest for a longer duration, for example, more than 5 years, it is advisable to invest in mutual fund SIPs since these can offer better returns in the long run. RDs are ideal for meeting short-term savings goals, whereas SIPs help in achieving long-term wealth creation goals.

Taxation

Interest earnings on RD are added to one’s taxable income and are taxed as per the applicable income tax slab of the investor.

Returns from mutual fund SIPs are dependent on the type of mutual fund scheme invested. Depending on the holding period of the fund units, Short Term Capital Gains Tax or Long Term Capital Gains Tax may be applicable and these differ across equity and debt mutual funds. 

Equity Linked Savings Scheme (ELSS) investment is eligible for a tax deduction of up to Rs. 1.5 lakh under Section 80(C) of the IT Act. However, the tax benefit can be availed only if each SIP instalment is locked in for 3 years.

Conclusion

While choosing between SIPs and RDs, an investor must consider aspects such as personal income, risk appetite, investment time horizon, and specific investment goals. For those who can take comparatively higher risk and can remain invested for a longer duration, a mutual fund SIP can prove beneficial. Those who wish to minimize risk can invest in a debt fund for portfolio diversification. RDs can be used when there is no risk appetite and one wants to simply park aside extra funds without expecting larger returns.

FAQs

Is SIP better than FD?

Mutual fund SIPs offer better opportunities for wealth creation and regular income in the long run as compared to FD returns. This is because FD returns are fixed and SIP returns could vary depending on market conditions.

How to invest in SIPs?

To start an SIP investment, you can download the Finity app on your smartphone and explore a wide range of mutual fund options. The app allows you to select a fund based on your risk/return appetite and investment time horizon.

Can SIP make you rich?

SIP can result in wealth creation and regular income in the long run depending on the plan selected and investment time horizon of the investor.

Can I withdraw SIP anytime?

Yes, except for ELSS investment, you can withdraw SIP at any time. Some funds may charge an exit load depending on specific terms of the scheme.

Is Daily SIP better than monthly SIP?

Daily SIPs mean investing in smaller proportions as compared to monthly SIPs. Thus, daily SIPs can help in limiting the losses on investment by minimising the risk. Daily SIP returns are generally lower than monthly SIPs

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