Which is Better SIP Or RD?
Systematic Investment Plan (SIP) and Recurring Deposit (RD) are two popular ways in India to create wealth over a more extended period. While SIP involves setting up a fixed amount at fixed intervals for investment in mutual fund schemes, RD is a savings scheme requiring monthly payments.
Those looking to build a significant corpus through payments at regular intervals can opt for either RD or SIP. The following sections include an analysis of SIP vs RD to help individuals choose the most preferred option.
What is SIP?
A Systematic Investment Plan (SIP) is a method of investing a fixed amount in mutual fund schemes at regular intervals, such as monthly or quarterly. This allows investors to accumulate units in a mutual fund scheme over time, benefiting from market fluctuations. SIPs are ideal for long-term wealth creation, offering small, regular investments without the need to time the market.
Benefits of SIP
With consistent investing, SIP can help you build a significant corpus. Some of the key advantages are:
- Rupee Cost Averaging: SIPs help reduce the average cost of investment by buying more units when prices are low and fewer when prices are high.
- Discipline in Investing: Regular contributions foster disciplined investing, ensuring consistency in building wealth.
- Compounding Potential: SIPs allow compounding of returns, increasing wealth over time.
- Affordable: SIPs are accessible with low initial investments, starting from as little as Rs 500 per month.
- Flexibility: Investors can modify contributions or pause investments as needed.
- Long-Term Growth: SIPs are effective in achieving long-term financial goals, such as retirement.
- Tax Benefits (for ELSS SIPs): SIPs in ELSS mutual funds offer tax deductions under Section 80C.
Drawbacks of SIP
Before investing in SIP, understand the following limitations:
- Market Risk: SIPs are subject to market fluctuations, and returns are not guaranteed.
- No Guaranteed Returns: Returns depend on market performance and fund types.
- Long-Term Commitment: SIPs work best over the long term; short-term gains may not be significant.
- Exit Load Fees: Some funds charge fees for early redemption, limiting flexibility.
- Not Ideal for Immediate Income: SIPs are focused on capital growth, not regular income.
- Requires Consistent Contributions: Regular payments are necessary, and disruptions can affect long-term goals.
- Economic Sensitivity: Economic downturns can negatively impact returns, especially for equity-based SIPs.
What is RD?
A Recurring Deposit (RD) is a savings scheme where investors deposit a fixed amount of money every month into their account for a specified tenure. The amount earns a fixed interest rate, and at the end of the tenure, the investor receives the principal along with the accrued interest. RDs are ideal for individuals seeking guaranteed returns with low risk.
Benefits of RD
RD has a lower risk than mutual fund investments and, thus, lower return potential. Some of the benefits of investing in RD are:
- Fixed Returns: RDs offer guaranteed returns based on the interest rate set at the time of investment.
- Safe Investment: With minimal risk, RDs are ideal for conservative investors who prefer stability.
- Easy to Set Up: RDs require minimal documentation and are easy to open with most banks and financial institutions.
- Predictable Income: Investors can predict their returns and plan their finances accordingly, as the interest rate is fixed.
- Tax Benefits: While RDs don’t offer direct tax deductions, the interest earned may be eligible for tax-saving schemes if invested in tax-saving RDs.
- Flexibility in Tenure: The tenure of an RD can range from 6 months to 10 years, offering flexibility for different financial goals.
Drawbacks of RD
While RD is a relatively safer investment avenue, it also has the following limitations:
- Lower Returns: The interest rates on RDs are lower compared to other market-linked instruments like mutual funds or equities.
- Inflation Risk: Fixed returns may not keep pace with inflation, eroding purchasing power over time.
- Tax on Interest: The interest earned on RDs is taxable based on the individual’s tax slab, reducing the overall returns.
- Premature Withdrawal Penalties: RDs impose a penalty for early withdrawal, making it less liquid than other investment options.
- No Compounding of Interest: Interest is usually paid at maturity or quarterly and doesn’t compound, limiting the potential for growth.
Difference Between RD and SIP
Here is a tabular representation laying out the differences between RD and SIP:
|
Parameters |
Systematic Investment Plan |
Recurring Deposit |
|
Investment Type |
Individuals invest their money in a mutual fund scheme at fixed intervals such as quarterly, monthly, or semi-annually. |
Investors will have to pay a certain amount each month. |
|
Returns |
The mutual funds' SIP returns have been varying between 12% and 22% for the past 5 to 10 years. Note that the returns are not guaranteed. |
The interest rates have varied between 5% and 9%. There are special rates applicable for senior citizens. Returns are fixed because RDs come with fixed interest rates. |
|
Tenure |
SIPs do not have any specific tenure. |
The maturity period of RDs lies anywhere between six months and 10 years. |
|
Scheme |
Investors can invest in equity or debt funds based on their investment objectives and risk-bearing capacity. |
Those looking for flexibility can opt for flexible RDs. |
|
Risk |
The risks associated with SIPs will depend on the type of mutual fund one picks and the overall market condition. However, one can avert such risks by investing over an extended period. |
This is one of the safest investments. There is practically no risk involved with recurring deposits. |
|
Taxation |
Taxation is applicable on one’s STCG and LTCG. |
Income received from recurring deposits is not eligible for tax exemption or deduction. Instead, the earnings are taxed per the tax slab applicable to the individual. |
|
Liquidity |
SIP offers comparatively better liquidity. One can close an SIP and withdraw money anytime. However, they may have to pay an exit load if they redeem the units before a specific period. |
Recurring deposits also provide liquidity, but it involves payment of pre-withdrawal charges for premature withdrawals. |
|
Suitable for |
This is suitable for both conservative and aggressive investors. |
This is most suitable for conservative investors. |
SIP vs RD: Which is Better?
Systematic Investment Plans and recurring deposits are pretty popular instruments for wealth creation. However, the two most significant factors individuals usually check before investing their money are risk factors and returns generated.
While RDs are a highly secure investment option, some risks will be associated with SIP investments. That said, mutual fund SIPs can easily cater to individuals with varying risk profiles.
Regarding returns, RDs generate a fixed income as per the interest rate the banks decide. On the other hand, income from SIP will vary as the returns are not selected and usually depend on the market conditions, types of securities invested in, etc.
A recurring deposit would be ideal for conservative investors who are not keen on taking risks. On the other hand, a mutual fund SIP can be a viable option for both conservative and aggressive investors as it is designed for investors with different risk appetites.
However, before choosing between SIP and RD, investors need to know their investment objectives and risk appetite. This will help them to make an informed choice.
Along with this, you can first calculate and plan your investments with the SIP or Online RD Calculator. Such a tool can prove to be of great assistance in computing how much you should invest to avail yourself of a certain return in future.
Final Word
SIPs offer higher growth potential through market-linked returns, making them ideal for long-term investors willing to tolerate market volatility. In contrast, RDs provide guaranteed returns with minimal risk, making them suitable for conservative investors seeking stability and predictability. By understanding your investment objectives and risk appetite, you can select the option that best aligns with your financial needs, with both SIPs and RDs playing important roles in a diversified investment strategy.