According to data put out by AMFI, there are more than 1.50 crore SIP folios in India and SIPs are contributing nearly Rs.4300 crore of inflows each month. The Indian mutual funds is consistently adding over 6.50 lakh SIP accounts each month and that possibly explains how the retail investors are indirectly participating in the equity markets. What is more important at this stage is how to get maximum return from SIP and how to benefit from mutual funds through the SIP rout?. Here is a 6 point framework to understand key SIP benefits and risks..
1. Tie your SIP to a long term goal and please think long term..
First thing you need to remember about a mutual fund SIP is that they work best when designed around equity funds. Obviously, when you talk of equity funds, you are talking about the very long term. Take a minimum time frame of 8-10 years as that will enable your equity fund to automatically smoothen out the vagaries of the equity market. But SIP is all about discipline and to instil that discipline you need to tie your SIP to a long term goal. So, any equity SIP that you operate must be tied to a long term goal like retirement, child’s education, child’s wedding etc. That will give you clarity in SIP expectations.
2. Ensure that your SIP is designed looking at your risk parameters
You cannot design your SIP without considering your risk parameters. What do we mean by risk parameters? Let us say that you are doing a SIP to pay your home loan margin after 3 years. Obviously, that is too short a time frame to rely on equities and so that should be an SIP on debt funds. If the tenure is shorter then you must rely on a liquid fund or a liquid plus fund. Even within equity funds, sectoral funds and thematic funds are more risky than diversified equity. If you are opting for sectoral or thematic funds then ensure two things. Firstly, ensure it is only a small proportion of your total corpus. Secondly, ensure that you don’t continue the SIP once valuations get rich.
3. Use a foolproof framework to select funds for the SIP
It is not enough to day that you want to start an equity mutual fund SIP. You need a stringent framework to select funds for your SIP. What are the parameters to consider here? Firstly, look at the pedigree and the AUM of the fund. These will give you an assurance that the funds are here for the long term. Secondly, ensure that the fund management team does not keep changing too often. The longer the team stays together, the more consistent is the investment policy and investment philosophy. Thirdly, look at the returns performance and ensure that over the longer period they beat the Total Returns Index (TRI) in most of the years. Occasional underperformance is fine but you cannot be consistently doing worse than the index.
4. Make a choice between regular plans and direct plans based on your needs
When you invest in mutual fund SIPs, you have the choice between regular plans and direct plans. Direct plans do not have entry loads or trail loads and hence their NAV tends to be higher than regular plans. When you opt for regular plans you get the benefits of an advisor who helps you make the right fund choice. In case you feel that you are capable of doing the fund selection on your own, you can opt for the direct plans. Returns will be higher in a direct plan due to lower expense ratio compared to regular plans.
5. Focus on time rather than timing
The question is whether you should increase your SIP amount when markets are down and decrease your SIP amount when markets are up? Frankly, that is not advisable for three reasons. Firstly, 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. Secondly, the incremental benefit of timing the market is very minimal over a longer period of time and the incremental benefits do not justify the effort. Lastly, the whole idea of equity SIP is to focus on time rather than on timing. Why change the script in the first place?
6. Constantly benchmark your SIP with an index fund SIP
What do we understand by benchmarking? You invest in a SIP so that you get the benefits of active fund management. If you are only going to earn index returns then you are better off taking lower risk in an index fund. Your equity SIP needs to outperform the index fund SIP by a reasonable margin to be really justified. Don’t compare with index absolute returns but compare with an index fund SIP as that will give you a much clearer picture.
An equity SIP is not just about jumping into any equity fund but it is about carefully selecting and monitoring the performance of your SIP. Above all, the golden rule is that your SIP must fit into your overall financial plan and it should be tied to a specific goal. That is what provides a proper time frame to your SIP and also helps you to decide when to continue with the SIP and when to convert into a debt SIP or a liquid SIP as your goalposts approach!