How SIPs Can Help You Maintain Stable Financial Health

8 minsNovember 19, 2017

Many of us get a health check-up done at regular intervals. We recognise the importance of being in pink of our health to make our dreams come true and provide the best to our family. However, what most of us often forget is that ‘financial health’ also plays a critical role to meet many aspirations of life –that’s the bitter truth!

Hence, as much as a regular medical health, a Financial Health Check-up, too, is essential for your wellbeing at every phase of life. It is irrespective of how much you earn per month and who you are.

Your financial security lies in being completely in control of your personal finances. Therefore, focus on your budgets, lower your expenses; so that you save more and accomplish the envisioned financial goals. Ideally, as Warren Buffett says, “Don’t save what is left after spending, but spend what is left after savings”.

Further, your savings need to be parked in investment avenues that are productive, whereby you benefit from the power of compounding, grow your wealth and counter the inflation bug better, as it otherwise erodes the purchasing power of your hard-earned money.

Investing in mutual funds is a promising avenue for wealth creation. The top-6 benefits of investing in mutual funds are:

• Diversification;
• Professional management;
• Lower entry level (you can start with as little as Rs 500);
• Economies of scale;
• Liquidity; and
• Innovative plans/services for investors (SIP/STP/SWP)

But selecting the best mutual fund schemes in accordance to your risk profile, investment objectives, and investment horizon, is a critical task.

There are various categories of mutual funds — broadly equity, debt, hybrid, gold, and so on. Plus, a galore of sub-categories, each having their own investment mandate to achieve the stated investment objectives. Strategizing the investment portfolio by recognising your financial needs/objectives, which could be the following, is essential:

• Growth
• Income
• Inflation protection
• Peace of mind
• Preservation of capital and
• Tax saving

Subscribing to the investment approach and portfolios of friends and relatives may not always reap the best results. This is because every individual’s risk appetite, investment objectives, financial goals, circumstances, investment horizon, and other circumstances are different.

Thus, take extra time and care to align your portfolio prudently!

SIP for wealth creation

For systematic wealth creation over the long-term, Systematic Investment Plans (or SIPs) offered by mutual funds are a good mode, where using an SIP calculator is an option, like a bank recurring deposit, works on the simple principle of investing regularly. Plus, it enforces discipline as your hard-earned money gets parked (debited from the bank account) either daily, monthly, quarterly in a respective mutual fund scheme.

Here are 5 benefits of SIPs:

• SIPs are lighter on the wallet
  • SIPs facilitate you to invest in smaller amounts at regular intervals (daily, monthly or quarterly). This in turn reduces your burden of defraying a lump-sum - at one go - from your bank account. If you cannot invest Rs 50,000 in one shot, that's not a huge stumbling block. The SIP route enables investments as low as Rs 500 per month.
• SIPs make market timing irrelevant
  • Timing the market can be hazardous to your wealth and health. Instead, focus on 'time in the market' in the endeavour to create wealth by selecting the best mutual fund schemes with a dependable track record through SIPs and staying invested for the long-term. And if market volatility worries you, SIPs in fact can aid in managing (even-out) that volatility and prove effective, particularly when markets are at high.
• Enables rupee-cost averaging
  • Many a times, a SIP works better as opposed to investing a lump sum one-time. This is because of rupee-cost averaging. Under rupee-cost averaging, you typically buy more units of a mutual fund scheme when prices are low, and buy fewer mutual units when prices are high. This infuses good discipline because it forces you to commit cash at market lows, when other investors around you are wary and exiting the market. It also enables you to lower the average cost of your investments.
• Offers the benefit of power of compounding
  Along with the habit of investing regularly, SIPs power your investments with the benefit of compounding.
  • For example, a monthly SIP of Rs 1,000, in a mutual fund scheme with an appealing track record following robust investment processes & systems, can aid you build a corpus of approximately Rs 9.99 lakh over a 20 years investment horizon with a modest 12% annualized growth rate in equities.
  • And if the equity market performs better, the corpus can be even greater provided the fund selection is apt.
  • So, over the long-term, SIPs can compound wealth productively and systematically.
• SIPs are an effective medium of goal planning
  • Buying a dream home, a car, providing good education to children, travelling abroad for leisure, and retirement are some of the vital financial goals of life. Once you have realistically identified the corpus needed to fulfil such goals, SIP-ping regularly in deserving mutual fund schemes can help in effectively achieving the financial goals.
  • Notwithstanding the above, even to tide over contingencies, viz. loss of job, loss due to natural calamity, medical emergency and so on, SIPs in appropriate mutual fund schemes—can come to your rescue.

Are there any best SIPs?

Well, by now you know that SIPs are a medium to invest in mutual funds. Hence, there's nothing like 'best SIPs'.

You need to select mutual fund schemes in congruence to your needs to accomplish the envisioned financial goals, and in the interest of long-term financial wellbeing.

Some guidance to select winning mutual fund schemes for your portfolio

• Performance:

  The past performance of a fund is important in analysing a mutual fund. But, remember that past performance is not everything, as it may or may not be sustained in future. Therefore, it should not be used as a basis for comparison with other investments.It just indicates the fund’s ability to clock returns across market conditions. And, if the fund has a well-established track record, there is a higher likelihood of it performing well in the future, than a fund which has not performed well.

  Under the performance criteria, you must make a note of the following:

  • Comparison:
    • A fund’s performance in isolation does not indicate anything. Hence, it becomes crucial to compare the fund with its benchmark index and its peers, so as to deduce a meaningful inference. Again, one must be careful while selecting peers for comparison. For instance, it doesn’t make sense comparing the performance of a mid-cap fund to that of a large-cap. Remember: Don’t compare apples with oranges.
  • Time period:
    • It is very important that you as an investor have a long-term horizon (of at least 3-5 years) if you wish to invest in equity oriented funds. So, it becomes crucial to evaluate the long-term performance of the funds. However this does not imply that the short term performance should be ignored. Besides, it is equally important to evaluate how a fund has performed over different market cycles (especially during the downturn). During a rally it is easy for a fund to deliver above-average returns; but the true measure of its performance is when it posts higher returns than its benchmark and peers during the downturn.
  • Returns:
    • Returns are obviously one of the important parameters that one must look at while evaluating a fund. But remember, it is not the only parameter. Many investors simply invest in a fund because it has given higher returns. Such an approach when making investments is incomplete. In addition to the returns, one also needs to look at the risk parameters, which explains how much risk the fund has undertaken to clock higher returns.
    • Risk: To put it simply, risk is a result or outcome which is other than what is/was expected. The outcome, when different from the expected outcome is referred to as a deviation. When we talk about the expected outcome, we are referring to the average; or what is technically called the mean of the multiple outcomes. Filtering it further, the term risk simply means deviation from average or mean return.
      Risk is normally measured by Standard Deviation (SD or STDEV) and signifies the degree of risk the fund has exposed its investors to. From an investor’s perspective, evaluating a fund on risk parameters is important because it will help you check whether the fund’s risk profile is in line with your risk profile or not. For example, if two funds have delivered similar returns, then as a prudent investor, invest in the fund which has taken less risk, i.e. the fund that has a lower SD.
  • Risk-adjusted return:
    • This is normally measured by Sharpe Ratio (SR). It signifies how much return a fund has delivered vis-à-vis the risk taken. Higher the Sharpe Ratio better is the fund’s performance. As an investor, it is important to be cognizant of this because you should choose a fund which has delivered higher risk-adjusted returns. In fact, this ratio tells whether the high returns of a fund are attributed to good investment decisions, or to higher risk.
  • Portfolio Concentration:
    • Funds that have a high concentration in particular stocks or sectors tend to be very risky and volatile. Hence, you should invest in these funds only if you have a high risk appetite. Ideally, a well-diversified fund should hold no more than 50% of its assets in its top-10 stock holdings. Remember: Make sure your fund does not put all its eggs in one basket.
  • Portfolio Turnover:
    • The portfolio turnover rate refers to the frequency with which stocks are bought and sold in a fund’s portfolio. Higher the turnover rate, higher the volatility. The fund might not always be able to adequately compensate you for the higher risk taken. So, if you want lower volatility, invest in funds with a low portfolio turnover rate.


• Costs:
  

  If two funds are similar in most contexts, it might not be worth buying mutual fund scheme that has a high costs associated with it, only for a marginally better performance than the other. Simply put, there is no reason for a mutual fund house to incur higher costs, other than its desire to have higher margins.

  The two main costs incurred are:

  • Expense Ratio:
    • Annual expenses involved in running the mutual fund include administrative costs, management salary, overheads, etc. Expense Ratio is the percentage of assets that go towards these expenses. Every time the fund manager churns his portfolio, he pays a brokerage fee, which is ultimately borne by you, the investor, in the form of an expense ratio.
  • Exit Load:
    • After SEBI’s ban on entry loads in 2009, as an investor, you now have only exit loads to worry about. An exit load is charged when you sell your units of a mutual fund scheme within a particular tenure. Most funds charge if the units are sold within a year from date of purchase. As the exit load is a fraction of the NAV, it eats into your investment value.

"Becoming wealthy is not a matter of how much you earn, who your parents are, or what you do... it is a matter of managing your money properly." – Noel Whittaker

Happy Investing!

Disclaimer: This article has been authored by PersonalFN, a Mumbai based Financial Planning and Mutual Fund research firm known for offering unbiased and honest opinion on investing. Axis bank doesn't influence any views of the author in any way. Axis Bank & PersonalFN shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.