A systematic investment plan (SIP) has to be designed for the long term. That is the first condition. Secondly, all SIPs must have a context and that context has to be your long term goals. We normally believe that SIPs will generate returns by default in the long run. In fact, studies have consistently proven that SIPs in equities held for a period of more than 8 years almost reduces the downside risk to nil. That means; you will earn positive returns although the extent of positive returns may or may not meet your expectations. The moral of the story is that your equity SIP may not be safe in the traditional sense of the term but it surely is going to help you generate wealth in the long run. Even as we look for the best SIP portfolio for long term investment, we need to also look at the pros and cons of SIP investment. The answer to the question, “Is it safe to invest in SIPs” would be; it depends.
SIPs have the potential to generate wealth with low levels of risk over time. However, there are some basic assumptions. Here are 4 such assumptions..
1. You have to start as early as possible
Any kind of wealth creation will only work if it starts early. The earlier you start, the longer you contribute and the longer your principal contribution earns returns. That means your returns compound for longer and therefore earns more returns. There is another angle to starting your SIP early. Mutual fund performance is not always as per your expectations. The longer your time frame, the more time you have for corrective action in case your investment goes against you. Also, time is an automatic regulator of your portfolio volatility and that makes it a lot safer. Typically, the standard deviation of a SIP will be much lower over 25 years compared to a 10-year period. You need to make time and volatility work in your favour when you are evaluating your SIPs.
2. Avoid the temptation of payouts and stick to growth plans
Don’t go for the lure of regular payouts in the form of dividends. Dividends not only withdraw part of your wealth, but also reducing the compounding effect. If you opt for a dividend plan and then reinvest the dividends at the same rate of yield then your wealth will be neutral. But that is rarely followed in practice. The better option will be to opt for growth plans where compounding is automatic. Let us look at the case of a monthly SIP of Rs.5,000 per month for 25 years. Fund A is a growth, Fund B is a dividend which pays out 25% of profits and Fund C is a dividend plan that pays out 50% of its profits. How will the final wealth be impacted?
ParticularsFund A – Growth PlanFund B – Dividend Plan 25% payoutFund C – Dividend Plan 50% payoutMonthly SIPRs.5,000Rs.5,000Rs.5,000Annual CAGR Returns16%16%16%Compounding after dividend payout16%12%8%Total Contribution over 25 yearsRs.15 lakhsRs.15 lakhsRs.15 lakhsInvestment value after 25 yearsRs.1.98 croreRs.94.88 lakhsRs.47.87 lakhsWealth Ratio13.2 times6.3 times3.2 times
It is obvious that the growth plan is more catalytic in creating wealth in the long run with lower levels of risk.
3. Make SIP a discipline on a regular basis
This is a point that is often ignored. Don’t try to time your SIP. Identifying the tops and the bottoms of the market is neither possible nor is it essential. The idea is to commit a fixed amount of SIP each month and then just stick to it. The best way is to classify your SIP into a core SIP and a satellite SIP. As long as the core SIP is not compromised, you can create wealth in the long run with calibrated risk.
4. Continuous monitoring and rebalancing is at the core of wealth creation
In many ways, this is the Holy Grail of creating wealth through SIPs. The whole idea of monitoring is to rebalance when required. There are three types of rebalancing that is required. Firstly, when you are stuck in bad funds that are underperforming you need to move out into better performers. Secondly, there is the need to temporarily reallocate part of your portfolio ahead of key macro expectations like interest rate shifts, macro shifts, inflation shifts, valuation shifts etc. Above all, the biggest rebalancing is passive and is allocation based. When your allocation to an asset class crosses a point then you need to reallocate it back to the original levels. This not only ensures profit booking at frothy levels but also helps you stay liquid when opportunities arise.
The bottom line is that equity funds can be a safe proposition if the risks are properly managed. That is the key to your long term SIP performance.
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