People often ask me, SIP vs RD, which is a better choice?
SIP means Systematic Investment Plan. It is an investment strategy offered by mutual funds to investors. An SIP allows an investor to invest small amounts of money regularly rather than investing a single large amount.
RD means Recurring Deposit. It is a special kind of deposit product offered by banks and post offices in India. In an RD a person invests a fixed amount every month for a specified duration. At the end, he gets back his investment and interest accrued.
The relationship between a Systematic Investment Plan to a vanilla Mutual Fund Investment is the same as that between a recurring deposit and a fixed deposit.
Who should worry about SIP vs RD?
This is applicable to those people who can invest small amounts on a regular basis. Such people usually have four investment avenues.
- Save cash every month in Savings Account.
- Open a Recurring Deposit account and start saving regularly.
- Open a Public Provident Fund (PPF) account and start investing regularly.
- Start a Systematic investment plan (SIP) with a good equity Mutual Fund.
In this article I will do a comparison of SIP and RD in terms of different parameters.
SIP vs RD – Structure of the Product
Systematic Investment Plan
A Systematic Investment Plan, also known as an SIP, is a mutual fund investment style that allows an investor to invest small amounts of money regularly rather than investing a single large amount.
With this money, the investor regularly gets units of the mutual fund, depending on the prevailing price of the fund called NAV (Net Asset Value).
For example if the NAV is Rs 71 and the amount invested this month is Rs 5000, the number of units the investor gets is 70.42.
Every month as and when the fund NAV changes, the investor will get different number of units. When the NAV is high, he will get lower number of units and when the NAV is low he will get higher number of units.
In a recurring deposit, a person invests a fixed amount every month for a specific period. At the end of the period, he gets back his investment and accrued interest.
SIP vs RD – Returns
An SIP is a mutual fund investment technique. Hence the returns are linked to markets and asset allocation strategy.
Investment Valuation = Investment Amount + Profit/Loss
An RD has the same interest rate as a fixed deposit of same tenure.
Maturity Value = Total Investment Amount + Accrued Interest
SIP vs RD – Volatility
Given the facts that mutual funds invest in market linked products like stocks and bonds, there may be significant volatility in the investment value.
An RD is a fixed income product and hence there is no volatility.
SIP vs RD – Goals and Investment Horizons
When one has short term goals (1 year to 3 year), a Recurring deposit makes sense, because the returns are assured although on the lower side. For a short term horizon, a person may be more willing to trade returns for assurance.
For example, if you intend to save money to buy an LED TV after 6 months, a Recurring deposit is the obvious choice.
However, when one has long term goals, like daughter’s education or son’s marriage or retirement planning (10+ year horizon), one is looking at returns, safety and potential for wealth building. For these kind of scenarios, an SIP in a good equity mutual fund is very good option.
Disclaimer: I have qualified the phrase mutual fund with the words good and equity. Equity as an asset class has given better returns than fixed income products over the long term in almost all free-market economies. And good mutual funds have been able to sustain their market edge for longer periods of time than ones which are not that good.
SIP vs RD – Asset Allocation
The choice between SIP and RD must also be seen in the context of overall portfolio asset allocation.
As mentioned above, equity as an asset class has the potential to provide higher returns than fixed income securities. An RD on the other hand being a fixed income product provides stability, security and assured returns.
Which is a better option?
- If you do not want to take any risks, RD is a better option. However, interest rate and returns are capped and not very high – may be 6% to 8%.
- If you are willing to take some risks, SIP in a good fund is a better option, and you can make much higher returns. I known some people who have made close to 15%.
- If you have a 5-year plan, safety is important. So RD is preferable in that case.
- If you are okay with longer duration, SIP in good fund is better option, as you will give time for your money to grow. Investing in equity is like planting a tree – you have to be patient to get the fruits.
You may also like
- Systematic Investment Plan
- Introduction to Rupee Cost Averaging
- Recurring Deposit
- Recurring deposit Vs fixed deposit
- Understand and Learn about Fixed Deposits
A Few Last Words
Before making any investment decision, please contact your financial adviser. I have provided this article for educational purpose only.
I hope you found this article on SIP vs RD useful. If you have something to add please leave a comment in the post. Please feel free to contact me.