Mutual Funds: What is a step-up SIP and how does it work?

A step-up Systematic Investment Plan (SIP) is an advanced version of the traditional SIP, tailored to address the evolving financial capacity of an investor. Unlike a regular SIP where the investment amount remains constant, a step-up SIP allows investors to increase their contribution periodically, typically on an annual basis. 

This strategy is particularly advantageous for those who expect their income to grow over time, such as young professionals or individuals anticipating regular salary increments.

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How does step-up SIP work?

Initial investment setup: The investor starts with a basic investment amount, just like in a regular SIP. For instance, they might begin with ₹5,000 per month.

Increments: The unique feature of step-up SIP is the predetermined periodic increase in the investment amount. The investor chooses how often they want to increase their SIP amount. Common frequencies include annually or semi-annually.

Step-up percentage or fixed amount: The investor decides on the increment, which can either be a fixed percentage or a fixed amount. For example, they might choose to increase their SIP by 10% every year or by ₹1,000 every year.

Automated adjustments: Once the parameters are set, the SIP amount automatically increases according to the chosen frequency and increment.

For example, Let’s consider an Indian investor, Priya, who is 30 years old and works as a software engineer. She wants to save for her retirement, which is 25 years away. Priya expects her salary to increase over time and wants to align her investments with her growing income. She decides to invest in a mutual fund through a step-up SIP.

Also Read: Magic of compounding: A monthly SIP of 10K in this mutual fund since inception would have grown to ₹1.76 crore

Initial setup

Initial SIP amount: Priya starts with a monthly SIP of ₹10,000.

Step-up frequency: Priya decides to increase her SIP amount annually.

Step-up increment: She opts for a 10% increase in her SIP amount every year.

Year-by-year breakdown

First 5 years of step-up SIP

Year 1: Priya invests ₹10,000 per month.

Total investment in year 1 = ₹10,000 * 12 = ₹1,20,000

Year 2: SIP increases by 10%, so Priya invests ₹11,000 per month.

Total investment in year 2 = ₹11,000 * 12 = ₹1,32,000

Year 3: SIP increases by another 10%, so Priya invests ₹12,100 per month.

Total investment in year 3 = ₹12,100 * 12 = ₹1,45,200

Year 4: SIP increases by another 10%, so Priya invests ₹13,310 per month.

Total investment in year 4 = ₹13,310 * 12 = ₹1,59,720

Year 5: SIP increases by another 10%, so Priya invests ₹14,641 per month.

Total investment in year 5 = ₹14,641 * 12 = ₹1,75,692

This pattern continues each year, with the SIP amount increasing by 10% annually.

Total investment and returns over 25 years - To understand the potential returns, let's assume an average annual return of 12% on the mutual fund investments. Using a SIP calculator or a financial tool that factors in the annual increase, we can estimate the future value of Priya’s investments.

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Summary of key calculations

Total investment over 25 years: The total amount Priya invests will grow each year due to the step-up feature. By calculating each year's investment and summing them up, we get a substantial corpus.

Potential returns: Given the power of compounding and the annual increase in the SIP amount, Priya's investment will grow significantly. A financial calculator or an Excel sheet can help compute the exact future value.

Here’s a simplified summary of the total investment and potential corpus after 25 years:

Total investment amount: The cumulative investment over 25 years, considering the annual 10% step-up, will be substantial.

Future value of investment: With an assumed annual return of 12%, the final corpus can be estimated.

Also Read: Switching SIPs Annually? Here’s why you might be losing out

Using a financial calculator

• By year 10, Priya’s monthly SIP would have increased to approximately ₹25,937.
• By year 20, her monthly SIP would be around ₹67,275.
• By year 25, the SIP amount would be roughly ₹1,08,347.

Let's approximate the future value using a step-up SIP calculator:

• Total amount invested over 25 years: Approximately ₹1.25 crore (assuming annual increments).
• Future value of the investment: Considering the compounding effect at 12% annual return, the future value can be approximately ₹7-8 crore.

In conclusion, the step-up SIP is an effective and strategic investment approach, where incomes are expected to rise steadily over time. By starting with a manageable SIP amount and incrementally increasing it at regular intervals, investors can harness the power of compounding more effectively. This method also ensures that investments keep pace with inflation, helping maintain the real value of money.

In the example of Priya, we see how a step-up SIP can significantly enhance long-term wealth accumulation. Starting with a monthly SIP of ₹10,000 and increasing it by 10% annually, Priya can build a substantial corpus over 25 years, potentially reaching ₹7-8 crore with an average annual return of 12%. This disciplined and automated approach not only simplifies the investment process but also aligns contributions with rising income levels, reducing financial strain while maximising potential returns.

Ultimately, a step-up SIP provides a structured and flexible pathway for investors to achieve their long-term financial goals. Whether planning for retirement, children’s education, or any other significant financial milestone, this investment strategy offers the dual benefits of increased wealth accumulation and inflation adjustment. By adopting a step-up SIP, investors can ensure a more secure and prosperous financial future.

Rohit Gyanchandani is Managing Director at Nandi Nivesh Private Limited