India now has more than 2.50 crore SIP accounts that are active and nearly Rs 8,000 crore flows into mutual funds each month in the form of systematic investment plans (SIPs). These are monthly-assured investments that are normally allocated to equity funds by retail investors and ensure long-term wealth creation. But there are some basic things to remember to make SIPs really effective. Here are the points to remember.
SIPs are not for instant gratification. It is in the long run that SIPs really make the power of compounding work in your favour. The minimum period you need to consider for an SIP must range from 8 to 10 years. If you try a three-year SIP, you are likely to be disappointed as the cycles may not really work in your favour. The longer your SIP sustains the more rupee cost averaging works in your favour to reduce your cost and enhance your returns.
SIPs work best when they are assigned to specific goals. Goals can be long term, medium term and short term. This helps you monitor your goals more effectively across milestones and take decisions on rebalancing if required. You can have multiple SIPs tied to a single goal or a single SIP tied to multiple goals. That is fine. What is important is that each SIP investment has a specific target goal, target amount and target date in mind.
Why is this risk-return trade-off so important? If you are doing an SIP to pay your home loan margin after 4 years, then it is too short a timeframe to rely on equities. An SIP on debt funds will work best in this case.
If the tenure is shorter then you must rely on a liquid fund or a liquid plus fund. Ideally, equity diversified funds work best when the goal is beyond 8 years. Make it a point to create these long-term goal SIPs on diversified equity funds or, at best, in multi cap funds. Sectoral and thematic funds are best avoided for SIPs tagged to goals.
You need a tight framework to select funds for your SIP. Here are a few pointers. Look at the pedigree and the AUM of the fund. This gives you an assurance that the funds are here for the long term. Secondly, the fund management team cannot keep changing too often. That is a sign of an unstable investment philosophy. Past returns do matter. More than absolute returns, focus on the consistency of returns. Such funds are more predictable.
Direct plans are those where you do not pay the marketing and trail fees. Hence the total expense ratio is lower and the returns are higher. When you opt for regular plans, you get the benefits of an advisor who helps you make the right fund choice.
If you are comfortable doing the fund selection on your own, you can opt for the direct plans. However, should you require guidance and handholding in the SIP process, it is better to opt for a regular plan.
Investors often ask if they should increase the SIP amount when markets correct and reduce the SIP amounts when markets go up. It is not only difficult but also does not add value in the final analysis. Remember, nobody has been able to catch the tops and the bottoms of the market so you could increase your allocation and see the market going down further. After all, the whole idea of equity SIP is to focus on time rather than on timing.
Last, but not the least, keep monitoring the performance of your SIP and its fit into your long-term goals. If your plan changes structurally, then your SIPs must change too. SIPs are not static and you need to tweak the liquidity of the SIP based on the goal timelines and the goalposts. That is the key!
The author is the Head of Research and ARQ – Angel Broking