We all know that Systematic Investment Plan or SIP is a relatively painless way of long term wealth creation. Once you put it in place, over the next few months, you become habituated to that amount being invested into mutual funds and barely feel the pinch of the reduced income left to spend. With the idea of rupee cost averaging, it’s also the best of both worlds – increased value of the fund during bull market and more money in the same fund in a bear market.
Let’s look at 5 commandments that you should consider in your SIP journey to make the most of this healthy financial habit.
1. Invest at least 10% of your salary every month
Often starting a new thing is the biggest stumbling block to it. Use this rule as a starting point. Ensure you are investing a minimum of 10% of your net salary every month into mutual funds. With this you are devoting atleast that 10% amount into taking care of your future self rather than living simply in the present or even in the past (by paying loan EMIs for things bought in the past).
2. Do it for the long term
This is one of the most important factors to remember. SIP is a habit that you should look to continue over a long period of time. It is only over a longer duration that the capital appreciation starts becoming visible and that you start reaping the benefits.
When you determine that you are doing SIP for the long term, you stop caring about short-term market volatility, choosing to look more at the bigger picture. In fact, you would then be able to gleefully look at any market downturn, knowing that your SIP money is going to buy you more units of the mutual fund.
3. Use it to fulfil long term goals and save taxes
Two important motives for which you must consider using SIP are – long term financial goals and to save taxes. When you plan for financial goals, many years prior to actually needing the money, SIP becomes a very handy tool. In that instance, SIP becomes like a piggy bank where over the years you end up with far more coins than you deposited.
As for taxation, the most important rule for any individual to know is Section 80C. Within Section 80C, you can save on your tax liability by choosing from various instruments like Public Provident Fund (PPF), Equity linked savings scheme (ELSS), Life Insurance, National Savings Certificate etc. While life insurance is essential for protection, the premium amount for an appropriate term life cover is barely going to be adequate. ELSS Mutual funds on the other hand not just help you save taxes but also have a much higher probability of appreciating in the future and come with the least lock-in period of 3 years. Win-win in our books!
4. Increase SIP amount with every increment
When you look at any communication about the benefits of SIP, most calculations take into account a consistent SIP amount over the years. Something on the lines of if you had invested Rs. 5000 every month for 20 years, today the amount would be equal to XYZ.
However, our salaries increase every year, atleast to match the march of inflation. Why then should the SIP amount remain stagnant? Even if you maintain just the first commandment of 10% savings into SIP every month, the amount should increase every year. As a practice, as soon as you get your increment letter, calculate the net amount of increment for each month and commit to investing a part of it by increasing your SIP. In that way, you will also protect yourself from the curse of lifestyle inflation.
5. Choose mutual funds on the basis of time horizon or objective
All mutual funds are not the same and to clear the confusion SEBI has mandated 16 categories. The three broad categories of mutual funds are on the basis of the asset class that they invest in – Equity, Debt and Hybrid (mix of equity, debt and cash). Equity is the category with highest risk and highest return as the performance is based on market returns. Debt, on the other hand invests in mostly fixed income instruments making it less risky with a higher probability of capital preservation but also lower returns. Hybrid, as a category is a more stable type of fund which helps with some market linked returns with a reduced volatility and risk.
When you start an SIP, it could be for different purposes with very different objectives and also the intended time for which it will stay invested. You must know the type of mutual fund and invest according to your risk appetite as well as the time horizon.
SIP is a simple tool and when used well, it can be a vital instrument to build wealth over the years. Using these 5 commandments, you will be well on your way to utilising SIP in the best way possible.