SIP vs Recurring Deposit: According to experts, taxation plays a crucial role in deciding the net returns of an investment.
When it comes to disciplined saving, both Systematic Investment Plans (SIPs) and Recurring Deposits (RDs) are popular choices. But when the goal is long-term wealth creation, the difference between these two options becomes significant.
Let’s explore how SIPs and RDs stack up, considering factors like returns, the power of compounding, informed risk, and tax efficiency.
1. The power of compounding over time According to Harsh Gahlaut, CEO & co-founder at FinEdge, compounding is often called the “eighth wonder of the world,” as small differences in returns can translate into substantial outcomes in long-term wealth accumulation. Let’s understand this with an example SIP Scenario: Investing Rs 10,000 per month in a mutual fund with an assumed 12 per cent annual return for 20 years can generate approximately Rs 99.9 lakh.
RD Scenario: Investing Rs 10,000 per month with an assumed 7 per cent annual return for 20 years can generate approximately Rs 52.4 lakh. This clearly shows that SIPs can generate almost double the corpus compared to RDs in the long run, purely due to the impact of higher returns compounded over time. 2. Aligning investments with financial goals While RDs provide guaranteed returns with minimal risk, they may not be sufficient for meeting long-term financial goals like retirement or children’s education. The objective should be to outpace inflation and generate real wealth. On the other hand, SIP investments in equity mutual funds help investors benefit from market growth, creating significant wealth in the long run. Additionally, the flexibility to increase SIP amounts (step-up SIPs) further enhances wealth creation potential. 3. Taking informed risk for long-term gains Risk and return are two sides of the same coin. While RDs are virtually risk-free, the 7 per cent return barely beats inflation, thus offering limited growth. On the other hand, SIPs involve market risk, but when invested consistently over a long period, the market volatility averages out, and the potential 12 per cent return helps in significantly outpacing inflation. This informed risk-taking is essential for long-term wealth creation. 4. Tax efficiency: A key differentiator According to experts, taxation plays a crucial role in deciding the net returns of an investment.
“The interest earned is fully taxable as per the individual’s income tax slab. For someone in the 30 per cent tax bracket, the effective return from a 7 per cent RD would reduce significantly. If held for more than one year, the returns on SIPs are classified as Long-Term Capital Gains (LTCG) and taxed at a favorable rate of 12.5 per cent in India. This makes SIPs more tax-efficient and adds to their attractiveness for long-term investing,” Gahlaut said. 5. The role of behaviour management in wealth creation Many investors fail to realise the potential of compounding due to behavioural biases like fear during market downturns or greed during booms. SIPs, with their automated investing mechanism, ensure discipline and reduce emotional decision-making. While recurring deposits provide safety and predictability, they fall short in terms of wealth creation potential due to lower returns and higher tax liability. On the contrary, systematic investment plans offer higher returns, tax efficiency, ability to beat inflation and accrue wealth for financial goals. “Investing through SIPs requires a long-term mindset and a disciplined approach. Compounding, combined with tax efficiency and goal alignment, makes SIPs a far more effective plan to build substantial wealth over time,” he concluded.
