Did you ever invest in mutual funds through the Systematic Investment Plan (SIP) method for a span of 5-7 years? If yes, then what we are about to say might come as a surprise if you are not well-versed with the nuances of mutual fund investing.But before we delve into this, let’s recap the basics of SIP mutual funds.
SIP permits an individual to invest a fixed amount periodically in their desired mutual funds, typically an equity mutual fund scheme. The investor decides the investment amount, the frequency, and the date on which the SIP investment takes place, depending on their financial goals and objectives, investment horizon, and risk appetite. Investment through SIP helps to generate wealth, thanks to rupeecost averaging and the power of compounding.
‘Equity mutual funds are extremely risky for a short-term duration. Always invest for a horizon of at least 5-7 years.’ You might have heard similar advice from several fund managers and advisors.We know now that this might sound contradictoryto what we said at the beginning of this article. But is that so? You are investing via SIP for a duration of 7 years. Isn’t that a long enough period? Isn’t this what these managers and advisors were talking about? Let’s understand.
The advice is to invest in equity mutual funds for 5-7 years, but that does not happen when you invest in SIP. Why? That is because the last SIP instalment would be very young at the end of 7 years, say 1 month (depending on the frequency of your SIP investments).More simply, only your first instalment would have completed 7 years.
A 5-7 year investment horizon is good investment decision but not for SIP investments. You can use a SIP Calculator to calculate the returns you would earn on your SIP investments and also tells you how much you would need to invest every month to earn a target corpus.For instance, you invest Rs500 in a mutual fund scheme and take out the money after 7 years. In this case, you can claim that you have invested for 7 years. However, when you invest through a monthly SIP of Rs500, things are a bit different. During the 5thyear, only the first SIP instalment would have completed 5 years while half of your SIP investments wouldn’teven have completed 3 years. Then how to invest in SIP?
Investors are often advised to follow the basic rules of asset allocation. You should pre-plan things like when to stop your investments and when to book profits. Further, depending on your financial goals, your equity exposure should ideally decrease with time. When you near your maturity period, you should stop your SIP investments. This leaves enough time for your last SIP instalmentto mature and protects you from any market downturn.
What’s more, if you suddenly stop your SIP investments at the end of 7 or 10 years, you end up paying an exit load or taxes on the SIP instalments that didn’t complete a year. So, it’s always advised to have a buffer of at least 1 year after you completely stop your SIP investments.
Mutual fund investments are subject to market risks. You should always read the policy offer documents carefully before investing. This holds true for SIP investments too. Happy Investing!