Summary of this article
There is no ideal SIP number. Only what you start with and continue with matters.
Underestimating inflation and expenses upon retirement is what messes people up more than math.
Consistency, step-ups and asset allocation are more important than returns.
Determining the right amount for your systematic investment plan (SIP) may seem rather straightforward for most financial models. However, the reality is less mathematical and more practical in how funds are managed (how you spend your money). The most important point to use when determining an SIP is the real rate of return, i.e., the amount of your returns, adjusted for inflation. This area is where most calculations go wrong.
How Do We Ideally Calculate SIP?
Here’s how you can arrive at the amount of SIP you might want to invest.
1) Clearly define your goal financially
2) Determine the time-frame for achieving that goal
3) Estimate your expected returns within that time-frame
4) Use the PMT / annuity formula to determine your monthly SIP payment
This will give you a fixed SIP amount to work from. However, this amount is only a starting point.
Wrong Goal Estimation: The Biggest Challenge
Take this for example: a college education that cost around Rs 20 lakh - 25 lakh in December 2010 would typically cost around Rs 50 lakh - 70 lakh by December 2022 if you assume a steady 8 per cent annual increase. But in reality, education costs - especially for professional degrees or studying abroad - have been rising much faster.
With fee hikes, higher living expenses and currency impact, these costs have grown at closer to 12-15 per cent a year. As a result, by December 2023, the same education could now set you back anywhere between Rs 1 crore and Rs 1.50 crore.
Says Sachin Jain, managing partner, Scripbox: “If you’ve been planning with a corpus of Rs 25 lakh - 50 lakh, you could fall significantly short of your goal, with enough funds to cover only a portion of the total cost. The real problem is that earlier estimates often underestimated future needs, leading to a gap between what was planned and what is actually required today.”
Structure SIP Around A ‘Sustainable’ Investment
Let's say you have calculated that your monthly SIP payment should be Rs 30,000 to fund your retirement. You start strong, but after 6-12 months, you become fatigued, which leads to either stopping or pausing your investments.
If you are planning to take a more practical approach towards your SIP, then work out how much you can comfortably save towards a monthly SIP, put that amount towards your monthly SIP, begin small and create a habit (Make monthly SIP contributions regularly), and lastly, step-up your SIP gradually (increment your SIP using the ‘step-up’ approach).
Don’t Ignore Asset Allocation
Also, don't ignore asset allocation.
Says Jain: “Don’t invest only in one asset class. Instead, diversify into various asset classes to create balance among your different assets.”
This will help you through various market conditions and allow you to be “weatherproofed” with your investment holdings. So, ensure that you invest according to your risk tolerance.
Biggest Mistake: Changing Your Strategy Midstream
When the markets are performing well, people tend to take on more risks with their investing. People also tend to try to accomplish too many goals at once with one pot of money when the market is performing well. Then, during market downturns, people tend to stop continuing with their SIPs.
Changing your investment strategy while trying to build long-term wealth is a bingo square.
Conclusion
There is no magic formula to determine how much dabbling in SIPs is appropriate. “It doesn’t matter if you get the math right or wrong. The important thing to remember is that you will have to realistically set your goals, make sustainable investment choices, diversify properly, and follow through with your disciplined efforts,” says Jain.
To reach your financial goals, start with what you can handle, be consistent, and gradually increase your investment.
