The importance of systematic investment plans (SIPs) is widely discussed when stock markets plumb lows as in recent times. In this article, we discuss two related concepts — SIPs and rupee-cost averaging (RCA).
SIPs versus RCA
There is a subtle difference between SIP and RCA. SIP is set up as an automatic debit from your monthly income. The objective of an SIP is to have a disciplined approach to saving. In contrast, RCA is a SIP set up for a short period. The key difference is that in RCA you have a choice between making lump-sum investment and spreading the investment over a pre-defined period.
For instance, you can set up a SIP for eight years on an index fund or an exchange-traded fund (ETF) if you are pursuing an eight-year goal.
In contrast, if you have ₹2 lakh in surplus cash, you may choose to invest the entire money now (lump-sum investing) or spread the investment over four months of ₹50,000 each (RCA).
There are certain factors that you must consider when setting up an SIP — a date for the SIP, the frequency and the length of the investment. A SIP is best set up on the day when your income is credited to your bank account. That way, you save first and spend the rest. Also, there is enough money in the bank account to process the SIP. You should typically have one SIP every month for each goal. Setting up more than one SIP every month is unlikely to complicate your investment process, but there may not be great benefits in doing so.
SIPs for trading
Even as you invest to achieve life goals, you should aim to capture short-term movements in the market. The most optimal way is to trade based on technical analysis. But not everyone is comfortable doing so. Setting up short-term SIPs with pre-determined rules can be an alternative to trading using technical analysis.
For instance, you may set up SIPs on Nifty ETF and Gold ETF for 12 months and take profits if the investment carries pre-defined, unrealised gains. It is best to define these gains in absolute terms than as percentages.
Note that your SIP should continue even as you take profits. The objective is to continually invest without timing the market.
Should you reinvest these trading gains or place the amount in a bank deposit? You could place the gains in a fixed deposit if you are within four years of achieving a life goal. Why? If your equity investment in your goal-based portfolio suffers losses during the last four years of the time horizon for the goal, you could use the deposit to bridge the shortfall. Otherwise, you could use the gains to increase your investment amount in your trading portfolio when the SIP is due for renewal.
SIPs are operationally efficient as you do not have to manually invest every month. The automated process also reduces regret as you distance yourself from taking active decisions each month. The biggest factor when setting up an SIP is to determine the investment amount. This is a function of the time horizon for your life goal, the amount you are willing to save towards achieving the goal and the importance of the goal.
You should set up the SIP through a direct plan with the asset management company (AMC). That way, you save on expenses that are otherwise paid as commissions when you use third-party service providers. You could reduce your expenses further by setting up an SIP on an ETF through your brokerage firm. Finally, check your investment statement each month to ensure that the units are correctly credited into your account.
(The author offers training programmes for individuals to manage their personal investments)