SIP vs Recurring Deposit: What’s Better for You?
Among various investment options available, Recurring Deposit (RD) and Systematic Investment Plan (SIP) are two of the most popular tools that allow you to invest small sums periodically in a planned manner.
The decision to choose between the two plans – SIP or recurring deposit – is driven by your risk appetite, return expectations and investment horizon. While both instruments have their share of differences, the best part is that you don’t have to commit a large sum of money to either. Moreover, both offer a degree of flexibility – you can close your account and withdraw anytime, depending on your financial health and cash flow requirements. But most importantly, SIP and RD are excellent for cultivating a savings habit. The two schemes can particularly benefit investors who have just started their careers or don’t have a substantial investible sum.
So, continue reading if you want to understand more about recurring deposits or SIP, including their differences, similarities and more.
What is RD?
A Recurring Deposit (RD) consists of a bank or post office deposit account in which you make monthly contributions after choosing the tenure and deposit amount. Having said that, some banks might even allow for quarterly or half-yearly deposits. You can invest for a minimum and maximum tenure of six months and ten years, respectively.
The risk is considerably low for all RD investments, and you can determine the deposit amount. Moreover, the interest is mainly compounded quarterly/half-yearly and paid at maturity. The rate, however, depends on your age, RD tenure and deposit amount. Deposits made by senior citizens attract a slightly higher interest rate.
The following categories of investors can invest in an RD scheme:
- Indian residents above 18 years of age.
- Indian residents, on behalf of their minor wards.
- Minors above ten years in their name.
- Private firms and Government organisations.
There is an option wherein you can set up a standing instruction to debit the deposit amount from your savings account and credit it to your RD account every month/quarter. While premature withdrawals are allowed, they do come with a penalty.
A recurring deposit is especially suitable for saving for specific financial goals such as car purchases or foreign trips. Most notably, it inculcates financial discipline as you start saving on a regular basis.
What is SIP?
A systematic Investment Plan (SIP) is an investment plan offered by Mutual Funds wherein one could invest a fixed amount in a mutual fund scheme periodically, at fixed intervals – say once a month, instead of making a lump-sum investment.
SIPs come in 3 forms – flexible, top-up and perpetual:
Under flexible SIPs, you can alter your instalments as per cash availability. This option is especially beneficial for investors with no fixed monthly income.
As the name defines, top-up SIPs allow you to change the instalment amount at predetermined intervals. For instance, suppose you have been investing Rs. 2000 in an equity fund monthly and would now like to increase your contribution to Rs.2,500 say increase by Rs. 500 every year.
What if you continually invest in SIPs and don’t want to limit your investments by caps of five or ten years? This is when you choose a perpetual SIP, as it allows you to invest for as long as you need.
One of the main advantages of SIP is that it enables you to set up an Electronic Clearance Service (ECS) mandate to debit the investment amount from your savings account. This feature makes SIPs extraordinarily convenient and hassle-free. Moreover, the return on equity mutual funds has high upside potential and has historically beaten the returns from fixed-income instruments.
Difference Between SIP and RD
|Instrument Type||Fixed income||Market linked|
|Investment Type||Deposit with a bank/post office.||Mutual Fund.|
|Tenure||Six months – ten years.||No fixed tenure.|
|Risk||Near-zero risk of losing returns or the principal amount.||Due to the market linkage, neither returns nor capital protection is guaranteed.|
|Return||The return is fixed and moderate in value.||Potential return is usually high compared to RD as observed historically.|
|Liquidity||An RD can be withdrawn anytime. However, there are penalties levied on premature termination of the account.||The SIP corpus is completely liquid and can be withdrawn anytime. The funds are credited back to your account within two days. Some funds charge exit load if you withdraw before a predetermined tenure.|
|Taxation during tenure||The interest income is taxable.||The gains on a SIP mutual fund are taxed only at redemption. However, dividend income from mutual funds is taxable.|
|Tax Exemption||Investment in bank RD is not tax-deductible. However, a tax saver term deposit of 5 years is eligible for tax deduction under Section 80C of the Income Tax Act.||You will get tax deductions of up to Rs. 1.5 lakhs per annum invested in an ELSS fund. On the other hand, if you invest in equity mutual funds for more than 12 months, you will be exempt from paying long-term capital gains tax upto a capital gain of Rs.1,00,000 in a financial year.|
|Investment Objectives||An RD helps meet short-term goals.||A SIP can be used for mid-term and long-term goals.|
Similarities Between RD and SIP
While the two differ on many accounts, there are still some similarities between an RD and SIP:
- Both instruments allow you to periodically invest small sums of money that eventually snowball into a large corpus.
- Both instruments help in developing a habit of saving from your monthly earnings.
- In both options, you can set up a standing instruction to debit the deposit amount from your savings account.
In deciding the right option from RD and SIP – you must first consider your risk appetite. While SIP is market-linked and risky, it has higher return potential in the long run. On the other hand, an RD gives you fixed returns at nearly zero risk. Nevertheless, as a means of cultivating a savings habit, both are equally advantageous, regardless of which one you select.
RD or SIP – which is better?
SIP is market-linked and hence riskier of the two. Having said that, it offers better returns on a long-term investment horizon. On the other hand, an RD gives assured returns and ensures the security of the capital.
Therefore, both have pros and cons and the right choice depends on your risk appetite and investment horizon.
Can I lose money in SIPs?
Yes, there is a possibility that you may lose the money invested in SIPs. Mutual funds are market-linked instruments where the investments are diversified across a pool of assets like stocks, bonds, commodities etc. All of these are subject to market risks. So, if the markets perform poorly, you may lose money.
What is the minimum time horizon for investing in a SIP?
There is no minimum or maximum time limit for investing in a SIP. However, SIPs give better returns when maintained for a longer time horizon say minimum of 3-5 years.
What is the minimum amount that I can deposit in an RD?
The minimum amount you can deposit varies from one bank to the other. You can start with as low as Rs. 100.
On what factors does the RD interest rate depend?
The interest rate on RDs depends on the applicant’s age, financial institution and tenure of the RD.
Can I change the deposit amount of the RD?
No. Once an RD is started, you cannot change the RD’s amount or tenure. However banks also offer flexi RD where you can deposit variable amount.