Summary of this article
7-5-3-1 SIP Rule answers:
What is a ‘long period’ while investing in equity funds through SIPs?
How many funds should you invest in?
What to do when markets turn volatile?
Systematic investment plans (SIPs) are among the most convenient ways to invest in mutual funds. It helps investors invest small and steady amounts on a regular basis in a disciplined manner. And if one is investing in equity mutual funds, such as large-, mid-, small- or flexi-cap funds, one can expect decent inflation-beating returns over a long period of time.
But how long should be considered as a ‘long period’ while investing in equity funds through SIPs? Also, how many mutual funds should you invest in to earn decent returns? And what to do when markets turn volatile?
The answer to all these very common questions often asked by new investors, lies in the ‘7-5-3-1 Rule of SIP’. Let’s understand what it means.
7: How long should you invest in equity mutual funds?
Here, 7 means you should invest in equity funds for a minimum of seven years. This is so because in the last 25 years, if you had invested in Nifty 50 index for at least seven years at any point of time, the risk of negative returns would have been nil and your chances of earning good returns would have been much higher.
Nifty 50 is an index that represents the largest 50 companies of the country.
Let’s look at the table below. It shows how often the Nifty 50 index has delivered different levels of returns across various time periods. So, chances of negative returns (losses) are the highest in the three year period and it falls to nil as the investment horizon becomes 7 years or longer.
Similarly, the chances of earning over 12 per cent returns is the highest over a 10-year period.
Note that this was about the large-cap funds. It may take longer for mid-caps and small-caps to reach their level of ‘no’ chances of nil returns, as they invest in relatively mid-sized and small companies with high levels of volatility and risk.
So, higher the time period, higher are your chances of earning better returns. However, do note that one should never time the market. There is no good or bad time to invest in the market. A disciplined approach to investing is the right way to create wealth for the long term.
5- For Building Your Portfolio
Next is 5, which represents diversification in your portfolio. Now, while you must diversify your investments, over-diversification is not recommended. Keep your investing simple. There are a variety of equity funds available in the market. Mutual fund companies also keep on launching new funds. But you don’t have to chase every trend. Don’t get into fear of missing out (FOMO).
According to the 5 thumb rule, your portfolio needs only five different types of equity funds, namely, large-, mid-, small-cap, international funds and, two funds with complimentary strategies, such as value and growth or factor funds like momentum and quality or momentum and value etc.
Alternatively, invest in flexi or multi-cap funds.
3- Sailing Through Volatile Times
Now, staying invested for a long time period is not an easy task. An investor has to be prepared to go through market ups and downs. So, 3 in the Rule of 7-5-3-1 represents the three tough phases of SIP disappointment.
Phase 1 represents a period of sub-par returns of around 7-8 per cent. Phase 2 represents the irritation phase when returns are even lower than that on fixed deposits; then comes the Panic phase when returns turn negative.
It is very common for an investor to get frustrated during any of these phases and exit the investments without giving it time for the compounding to do its magic.
If stuck here, one needs to understand how continuing your investments for a longer time period of seven years or more increases the chances of earning higher returns. So, in order to earn good returns in the long term, it is crucial to survive these three phases.
1- Increase Your SIP
Lastly, 1 means you should increase your monthly SIP amount every year. An annual step-up of 5 per cent or 10 per cent can make a huge difference to your final corpus.
For instance, look at this example. Let’s look at three scenarios.
Scenario 1: First, you invest Rs 10,000 through a monthly SIP in a fund that earns you 12 per cent returns. You continue investing for 20 years. In this case you would build a corpus of Rs 92 lakh.
Scenario 2: All things remain the same, but this time you increase your investments by 5 per cent every year. Here, you would build a corpus of Rs 1.27 crore.
Scenario 3: Here, you step up your monthly SIP amount by 10 per cent every year. So, you built a corpus of Rs 1.86 crore, double of what you made if you continue with the same amount of Rs 10,000 every month for 20 years.
So, by following certain thumb rules, you can get the most out of your mutual fund investments.
