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SIP and Mutual Funds Duration– AxisDirect
AxisDirect-O-Nomics
Nov 01, 2017 | Source: Value research
SIP duration for Mutual Fund Investments
It's a question that confuses many mutual fund investors once they buy into the concept of investing through a Systematic Investment Plan (SIP): When you have a lump sum to invest, then over what period should you spread the SIP? Of course, for most SIP investments, the question does not arise. The most common type of SIP investment is a monthly one that goes out of a monthly income. This sort of an SIP continues perpetually.
However, occasionally, the SIP investor gets a large sum of money suddenly. It could be a bonus from a workplace (although that's a rarity nowadays), or it could be the proceeds from the sale of some asset like real estate, or it could even be your retirement money which you need to spread and make it last for the rest of your life. As every saver should know, investing in an equity-backed mutual fund is the best way to get great returns over a long period like five to seven years or more. However, over shorter periods, equity funds are dangerous. And when you invest a large sum in one shot, then the risk is the highest. If the markets turn turtle, you could lose 10, 20 or even higher percentage of your invested amount very quickly. Since the beginning of the Sensex in April 1979, of the almost 13,900 possible six month periods, as many as 2,269 yielded a loss worse than 20 per cent. If you just happened to catch a period like that at the beginning, then you would lose a large chunk of your capital right before it even starts growing. In theory, you could eventually recover, but in practice you would probably panic and pull out your money, making your loss permanent.
The antidote to this is a Systematic Investment Plan. Spread out your investment at a monthly periodicity over a certain period. Your entry price will be averaged out and you will be saved from the risk of a sudden decline. Moreover, you will end up buying more units of the fund when the markets are lower, which will further enhance the returns you will eventually get. That is of course, the standard set of advantages that an SIP has. However, the vexing question is, what is this 'certain period' that I have referred to? Is it six months? One year? Two years? Or even longer? There are arguments for and against all these.
If you invest in an SIP over four years, then your risk of a loss is negligible. It's also interesting that the risk of loss and the chance of an outside gain are both higher over short periods. Over longer periods, the good times and the bad get averaged out and minima and the maxima converge. Consider this, for a typical fund with a multi-decade history, over all possible one year periods, the maximum returns are 160% and the minimum -57%. Over two years, this becomes 82% and -34%. Over three, 63% and -18%. Over five, 54% and 4%, meaning never any loss. Over ten years, the maximum is 30% and the minimum 13%. These are all annualised figures. The trade-off is crystal clear-the shorter the period, the higher the potential gain but the worse the possible risk.
The straightforward answer from this data appears to be that SIPs must last more than three years. And indeed, if you seek zero risk of loss, then that is the correct answer. However, for many investments, this is too long. If you are getting an annual bonus from your employer, then it would be ridiculous to spread it over three or four years. On the other hand, if you have sold some ancestral property and the sum realised will be the core of your old age income, then you need to be extra cautious about the risk you take. In a case like this, you would do well to forego some potential income in order to ensure that you don't make a loss.
One elegant rule of thumb is that you could invest the money over half the period that it has taken you to earn it, subject to the maximum of four to five years. So the annual bonus could be invested in six months, while the ancestral property could take five years. It's basically a way of linking risk to how significant that sum of money is for you.
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