There is normally a question asked if SIPs are safe, especially equity SIPs. The answer is that SIPs are as safe or as unsafe as your normal equity fund investment. The only advantage that the SIP brings to the table is the benefit of rupee cost averaging which enables you to reduce your cost of holding the SIP and therefore the Return on Investment. In fact it has been estimated that if you continue a SIP on equity diversified funds for over 8 years, then the probability of a downside in value is almost nil. Of course, you still need to earn more than the index returns but that is a different debate altogether.
The big challenge is not about how SIPs perform but how SIPs help reach your financial goals. Normally, each SIP is tagged to a specific financial and that is how you manage to track your journey towards the goal. Since financial goals are about the future, there is always an element of uncertainty involved and hence you need to simulate situations. In fact, your SIP amount must begin with simulations. Let us look at some SIP investment tips and some SIP long term investment ideas. Let us also look at the best SIP for long term investment in India and how simulation plays a key role in deciding the amount of SIP. Let us look at 6 kinds of simulations ahead of a SIP..
1. Simulating levels of income growth
This is the most basic assumption that you make. You monthly saving via SIP will be largely determined by your income growth. Obviously, your SIP cannot be static and needs to grow with your income. But you also need to be pragmatic. For example, your income is not going to increase at 15% annually through your career. There will be some very good years and some very bad years wherein you could stagnate or even take pay cuts. Your SIP should be divided into two parts; the core SIP and the satellite SIP. The core SIP is what you should be conservative but maintain under all circumstances. The satellite SIP is where you can keep your flexibility.
2. Simulating levels of expenditure growth
This aspect of projecting your expenditure has two very interesting aspects to it. Over time, not only will your costs go up but also your standard of living will go up as your expenditure patterns will shift. When you project your long term expenses post retirement, you need to consider your expenses and your liabilities. The second and more critical aspect pertains to your saving capacity. Normally, people tend to look at savings as a residual after spending. Instead, when you simulate, look at expenses as a residual item after your target savings are met. Then your potential savings can be classified into core and satellite as explained in the previous point.
3. Simulating costs of goals
How much does goal cost? That is the big question. When we talk of goals, we talk of goals like retirement, children’s education, children’s marriage, long term emergency corpus etc. These goals are simulated based on your projections of expenses after a period of time. Remember, most of these projections are deep into the future and hence we can only arrive at a reasonable estimate of the cost of these goals. A lot of the goals will actually get fine tuned along the way as the cost of goals gets crystallized better.
4. Simulating rate of inflation
This is, in a way, a part and parcel of your cost simulations. Inflation is the rate at which the costs will rise. Here again, the key is to be as liberal as possible to ensure that your incidental costs are covered. For example, if the current rate of inflation is 5% and the average of inflation has been 6% in the past, then you must ideally simulate two scenarios of 6% and 7% inflation so that you are protected in case of any exigency or any macro shock along the way.
5. Simulating return on debt investments
This is an interesting simulation and involves a lot of interesting assumptions. For example, your debt returns are a function of various factors. It will be a factor of the level of interest rates that will sustain. It will also be a function of the direction of interest rates. Normally, falling interest rates are positive for bond values and vice versa. To an extent, the returns on debt will also be contingent on the level of inflation discussed in the previous point. Above all, the spreads that corporate debt will earn over G-Secs and the spread the “AA” rated debt will earn over “AAA” rated debt will combine to determine how much returns you will make and therefore how you need to combine them.
6. Simulating return on equity investments
This is a slightly complicated part of it. Interest rates may be easier to extrapolate than equity rates. But there are some pointers. Firstly, there is a simulation of mid caps versus large cap returns. Secondly, there is a simulation of equity as an asset class. For example, equities have given over 14% returns annualized over the last 20 years and that can be taken as a benchmark with minor adjustments.
The whole purpose of simulation is to get a picture of how your SIP matches up to your goals under different scenarios. The more scenarios you simulate, the better prepared you are for any exigency.