SIP vs RD Which is a Better Option?

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.

  1. Save cash every month in Savings Account.
  2. Open a Recurring Deposit account and start saving regularly.
  3. Open a Public Provident Fund (PPF) account and start investing regularly.
  4. 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.

Recurring Deposit

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

Source

Hindu Business Line – SIP vs RD
Kotak Money Watch – SIP vs RD

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.

Subhodeep Mukhopadhyay

I am a Management Consultant in the Education Sector. In my previous corporate career, I have worked in Banking, Private Equity and Software industry. I am an MBA in Finance/ Computer Engineer and enjoy doing equity research and financial analysis in my free time.

5 thoughts on “SIP vs RD Which is a Better Option?

  • March 17, 2016 at 5:51 pm
    Permalink

    SIP OR RD WHICH IS BETTER

    Reply
  • February 2, 2017 at 11:59 pm
    Permalink

    Hi Subhodeep,
    It’s small but useful document. Thanks. I have a question, indeed few –
    1> Say I want to invest 2000/month and want to do it over 20 years period of time(no matter market crashes, or rises number of times in between)..In that case if I use internet available SIP calculators, they are all giving consistently almost similar estimate( say Rs. 3031910 (30.3 Lakhs) when I provided a 15% growth)..is this calculation correct? i.e. are they calculating based on an ‘assumption’ that stock market will continuously grow in an average rate of 15% for coming 20 years?!!
    OR they really calculate the risk of crashing, ups and downs , and then giving this estimation?
    (want to clarify the mathematics within)

    2> Secondly, is really ‘very’ long term SIP investment advisable? say, If i make this 2000 sip as my retirement fund, and continue investing for 35 years(!)–as per ‘calculator’ it’s going to yield 3Crore—Now is this something feasible for such very long term scenario -where we don’t know how market will behave, how many times crashes may occur, will there be any war.. what’s your advice?

    3> In very long term SIP investment, what should be the realistic growth expectation?10%?15%? or more or less?

    4> If I ask you to help me choosing such 5 funds(growth oriented,equity off course) ; what will be your top recommendation?

    Thanks for your time in advance… [you can also reply me over email, I shall love to contact you further.]

    Reply
    • February 11, 2017 at 4:01 pm
      Permalink

      1. calculators assume same interest rate every year – 15%
      2. my advice – yes it is advisable to invest long term in an SIP of an index fund.
      3. impossible to say – between 12% to 15% in an Indian market is reasonable in the long run. [Unless of course Congress/ CPIM comes back or Mamta becomes PM – then 0% probably ]
      4. No recommendations from my side – index funds are good all-round bet.

      Reply
  • March 18, 2017 at 9:11 am
    Permalink

    Very good article with supportive data. Redeeming a mutual fund is a bit tough for the customers who are dependent to others.

    Reply

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