Last week I was talking to a friend from another profession. He wanted some financial advice from me. I asked him all the usual questions an advisor would ask to know the purpose of investment but he did not have any specific goal in mind. All that he could say was but he was willing to do ‘SIP’. I said fine, I’d give him mutual funds and I asked him how long he could stay invested. He said he could invest for another 3 years. I said they are not the same. I again asked him when he needed this money. Does he need it for any purpose? He said, no, I don’t really need it until retirement. Great, then you can stay invested until retirement. He was confused at this stage.
He had many questions starting from whether I was going to suggest him SIPs at all (or just mutual funds) and about the period of SIP and what I meant by investment period.
Here is a summary of the responses I gave for the above questions.
SIP is not an instrument
Systematic investment plan or SIP is not an instrument of investment. It is just a method of investing into mutual funds. You can invest in mutual funds periodically or regularly (typically every month). Investing regularly helps navigate the volatility in the equity market and sometimes even in the debt market. The idea of a SIP is to buy through up and downs in the market so that you don’t time your entry wrong. The longer you do this, the higher the chances that you get averaging opportunities – that is – buy more in market dips. Hence, a SIP, especially in an equity fund is best done over at least 3-5 year period.
SIP period and investment holding period need not be the same
Most investors think you need to take out your money once the SIP instalment is done. This comes from their understanding of FD and RD. In a fixed deposit, you deposit the money once and hold it for a certain period of time. In a recurring deposit, you deposit regularly over a fixed period of time, and withdraw at the end of this time period. The time-frame, in such cases, is not decided based on your goals, but based on deposit tenure and the interest rates over such tenures offered by the banks. So, with this background you often tend to make two mistakes: one, you choose an arbitrary period of 3 years or 5 years to invest, relating it to a typically FD/RD lock-in period. This should not be done. Your savings and goal period should determine how long you need to run a SIP. Second, when your SIP instalments are done, you think it is time to withdraw. In case you had just a 1-year SIP period, you might think you should withdraw at the end of the 1st year. This is not true.
The fact is, with mutual funds, you can withdraw anytime. You can withdraw the balance while your SIP is running 0. You can hold your investments well after your SIP is stopped; as long as you wish to hold or until your goal nears. In other words, you can hold your investments long after your SIPs stop.
Having said that, when you are investing towards a goal, you need to make sure you save up enough for the goal. That means your tenure of the SIP must not be way away from your goal. For example, if you are investing for retirement, then you need to make sure you save for long enough a period so that you do not fall short of corpus when you retire.
What should be your SIP tenure
How long you need to invest depend on how much you can invest and what is your asset allocation and time frame. If you have just 2 years to go for your goal and cannot spare much sums, you may have to invest regularly through these 2 years. For example, if someone is investing Rs 1 lakh a month in an asset allocated portfolio that will fetch them 10% annually and wants Rs 1 crore in 10 years, then they can stop investing (or shift to safer options) even before the end of the 8th year since he would have reached the goal. However, somebody investing Rs 50,000 may have to stay invested over 10 years to reach there. This is the ideal scenario. But for those without goals, they should seek to keep their investment going as SIP is basically meant to provide discipline to your savings habit.
What happens when you choose short SIP tenures?
There are 2 pitfalls when you choose SIPs, especially in equity funds for short periods of say 1 year or less. First, you will not effectively average in the equity market, unless you are lucky to be investing through a falling market. You need to give time for SIPs to work. Second, while your intention would be to continue based on performance, there is a good chance (as seen by us) that you allow your SIP to expire and never restart.
What if the fund does not do well?
SIP is only a means to invest in mutual funds. So that means, you can change funds in which you SIP. You need not shorten the time frame of your investing for this purpose. For example, if you find your fund underperforming in the 2nd year of your holding it, you can seek advice to stop SIP in it and choose a better fund to start SIPs. The important thing is for the process of SIP to continue, so that you do not fall short of money when you near your goal. In other words, change funds in which you do a SIP if your fund is underperforming. Do not simply stop them or take a shorter time frame to test performance.