Saturday, May 14, 2011

Choosing the right tenure for your SIP :

Systematic investment plans (SIPs) are here to stay. Going by the growing number of SIPs, it does look like investors have taken to them in a big way. "Today as much as Rs 1,000 crore flow into SIPs every month," says Anup Bhaiya, MD and CEO, Money Honey Financial Services.

A SIP, as the name denotes, is a method to invest a fixed amount in amutual fund at regular intervals -- generally monthly or quarterly. It is easy to do and the minimum amount with most mutual funds is a mere Rs 1,000 per month. You can write post-dated cheques for your investment, or give an autodebit facility from your bank account.

In fact, most investors today prefer setting up an auto debit for their SIPs, since writing cheques is cumbersome. Also, you can choose any tenure that you want for your SIP — six months, one year, five years, 10 years or even opt for a perpetual SIP which will continue forever till you stop it. However, the moot question is what is the ideal tenure of an SIP?

The time factor
Financial planners feel that it is important to run equity SIPs for at least five years to maximise returns . "The important part in an equity SIP is to keep running it over a long period of time," says Bhaiya.
The numbers speak for themselves. Even if you had invested in the worst-performing SIPs and your time frame was 10 years or 15 years, you would still earn higher returns than a public provident fund (PPF). Reliance Growth Fund has been the best equity SIP over the past 10 years. If you had invested Rs 1,000 every month since April 2001, it would have given you Rs 10.57 lakh as on March 31, 2011. Interestingly enough, if you had invested Rs 1,000 every month on the worst-performing SIP, Taurus Discovery, you would have still ended up with Rs 2.25 lakh, giving you an annualised return of 11.66%, which is more than the 8% return that you could get from a PPF.

Now that does not mean that we are recommending that the investor should stop investing in PPF and start doing only SIPs. PPF is a totally different instrument, which is preferred by conservative investors who want the government guarantee and assured tax-free returns.

On the contrary, equity doesn't offer any assured returns and it can be extremely risky. "SIP scores over a lump-sum investment since you invest irrespective of the market condition," says Vishal Dhawan, founder, Plan Ahead Wealth Advisors. He recommends investors to do SIPs in diversified equity funds for long periods of time, typically more than five years.

Also, the advantage of investing irrespective of the state of the market ensures that averaging comes into play and allows the investor to benefit from volatility. Let's consider the past few months: The stock market has been volatile with alternate bouts of ups and downs due to reasons like high inflation and high crude prices. Hence, it is very difficult for retail investors to decide when to invest or to time their investments.

By buying more number of units at a lower price (i.e., when the market falls) and lower number of units at a higher price, you average your investments. Suppose the monthly SIP is for Rs 1,000 and the fund's net asset value (NAV) is Rs 20. This will lead to 50 units being credited to the investor.

However, in the next month, on account of the volatile markets, the fund's NAV falls to Rs 15. This will lower the average purchase cost; as a result, the investor will have 66.66 units credited to his account. In short, a SIP helps the investor buy more when the stock market is falling and buy less when it's rising.

Link it to your goals
SIPs work significantly better if wealth is to be created over a long term. They are an excellent tool for investors to build wealth in the early phase of life, especially when they do not have lump-sum money to invest.
Secondly, regular savings help build discipline amongst investors. Generally, financial planners recommend you do SIPs for a long duration and link it to your goals. "We recommend investors to go for goal-tenure SIPs and review them on an annual basis," says Sumeet Vaid, founder and CEO, Ffreedom Financial Planners.
Simply put, when going through the process of financial planning to meet each goal you could opt for a SIP. For example, if your child's education is 10 years down the line, you could go for a 10-year SIP. So assuming , an engineering course costs Rs 10 lakh today and assuming an inflation of 8% per annum, the same engineering course could cost Rs 21.58 lakh, 10 years down the line.
Now, in order to meet this expense, you could do an equity SIP of Rs 10,000 per month. Assuming you get a 12% return on equities, this will grow to Rs 23 lakh at the end of 10 years, thereby helping you meet your goals.

However, if luck is on your side, and you manage to reach the goal earlier, (say in eight years time, due to higher return from equities), you could consider shifting your corpus partly into debt, so that you do not expose your corpus to risk. When you choose to invest via a SIP, you make investments (usually ) in smaller denominations at regular intervals as opposed to making a lump-sum investment.
"SIPs can be used by investors of virtually all ages, keeping the underlying asset in mind," says Vishal Dhawan, founder, Plan Ahead Wealth Advisors. Just like every other investment, make sure that you also review your SIPs and take corrective action, if necessary.

This will ensure that your investments are on track and you do not miss your goals. Last but not the least, the most important point in SIPs is not to discontinue your SIPs in bad market conditions or when the market falls, as that will defeat the very purpose of investing.

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