A Rs 30,000 monthly investment at 12 per cent annual returns will roughly take around 12 years to reach your first Rs 1 crore and 20 years to reach Rs 3 crore. However, if you can increase your monthly SIP amount by 10 per cent every year you can reach the same Rs 1 crore in 10 years and Rs 3 crore in 16 years.
Systematic Investment Plan (SIP) is an investment route offered by Mutual Funds wherein one can invest a fixed amount in a Mutual Fund scheme at regular intervals– say once a month or once a quarter, instead of making a lump-sum investment. The instalment amount could be as little as Rs 500 a month and is similar to a recurring deposit. It’s convenient as you can give your bank standing instructions to debit the amount every month. From this money, the units of the funds are purchased at the applicable NAV (net asset value) which then earns returns based on the portfolio of stocks that the funds hold.
“Investing in mutual funds through the SIP route helps investors to average their cost of investments. Also, it helps in inculcating a habit of investing as each month, a portion of your salary is deducted from your account and invested. It also goes well with your money cycle – you earn every month, you spend every month and you invest every month,” said Value Research in a note
Why SIP is better than lumpsum?
Value Research believes SIPs solve the two main problems that prevent investors from getting the best possible returns from mutual funds. These are:
People try at time the market to buy at the bottom and sell at peaks
People invest at irregular intervals and then stop investing when markets fall
“Since SIPs mean regularly investing with a fixed sum regardless of the NAV or market level, investors automatically buy more units when the markets are low. This results in a lower average price, which translates to higher returns. If you invest a large sum in one go, you could end up catching a high point in the equity markets. This would mean that you would invest at a high NAV and reduce your gains if the market falls,” noted Value Research.
SIPs help people stay invested through the ups and downs of the market. Investors inevitably try to time the market. When the market falls, they sell and stop investing. When it rises, they invest more. This is the opposite of what should be done.”An SIP puts an end to all this by automating the process of investing regularly. It eliminates the mental load of deciding when to invest and leads to better returns,” noted Value Research.
Ten ways to make your SIP most rewarding
Now that you’re aware of the benefits, you can start investing in SIP by following the below steps:
- A SIP works most effectively when you are invested in equity funds. SIPs on debt funds cannot add much value because the power of compounding work much better on equity funds. It is only in equities that time works better than timing over the long run and hence the focus of SIP should be on equity funds and not on debt or liquid funds.
- SIP should be regular and systematic as the name suggests. Once you start a SIP, don’t stop it in between. When you stop the SIP, the compounding gets disrupted. Unless it is an absolute emergency, do not disrupt the SIP. Above all, always keep the SIP as rule based and as passive as possible. Don’t try to time SIPs with highs and lows.
- Check you can have funds on the date you set the SIP. Set a comfortable date for your SIP each month and ensure that you do not miss a single SIP. If you are opting for the ECS option for SIP ensure the bank account is funded well in advance. Don’t keep the SIP date too close to your salary dates.
- Where should you invest the SIP within equity funds. Your SIP should be ideally focused on diversified funds or in flexi cap funds. Avoid SIPs in thematic funds, small cap funds, mid-cap funds or sectoral funds. Long cycles of sectors and themes can result in underperformance over prolonged periods of time causing unnecessary pressure.
- Try out a stepped-up SIP if you cannot monitor your SIP amounts on a regular basis. That is because, your income typically increases on an annual basis, or at least in most of the years. What you need to focus on is that you step up the SIP so your savings and investment grow with your income levels. This also creates a reserve in case of any negative events.
- The golden rule is to always opt for a growth plan and not for a dividend plan in SIPs. Growth plan offers automatic reinvestment of returns and that is auto compounding. In case of dividend funds, the dividends must be invested at the same yield, which never really happens in most of our cases. The best way out is to focus on growth funds. It is also more tax efficient compared to dividend plans.
- Redeem the SIPs when the goals are approaching. However, you need to plan the redemption of your SIP smartly. For example, if you redeem in one shot then you pay 10% on capital gains in excess of Rs.1 lakh per year. A better choice is to spread redemption over 5 years to claim the benefit each year. Try to get your equity into debt or liquid funds at least 1 year before the goal to avoid negative surprises.
- The simplest way to make SIPs purposeful is to tag SIPs to goals. If you have 5 goals, then don’t try and spread across 25 SIPs. That is just too complex to handle. Stick to 6-8 SIPs and ensure that each SIP is specifically tagged to specific goals. It ensures the purpose of each SIP is clearly defined so there is no confusion.
- Review SIPs on a regular basis; perhaps every year. Ask some very fundamental probing questions like; are the funds outperforming the peer group, are they consistent, do they better the index; and the list can go on. This review helps you to decide on which SIPs to continue and which shift or terminate. If you are stuck in a bad SIP, you don’t have to be stuck forever. Use your discretion and think with your feet.
- Lastly, ensure that SIPs are aligned to long term goals. For example, as you age your risk appetite comes down and so should your equity allocation. If the SIPs in equity are becoming redundant to your asset mix, do a rethink. The answer is to shift from equity SIP to a debt SIP or even a liquid SIP if warranted. It is as simple as that.
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