What is SIP?
A Systematic Investment Plan or SIP is a planned mode for investing money in mutual funds. SIP allows you to invest a pre-determined amount at a regular interval (weekly, monthly, quarterly, etc.). SIP inculcates saving habit and building wealth for the future. SIPs have proved to be an ideal mode of investment for retail investors who do not have the resources to pursue active investments. An SIP is generally preferred for an equity scheme and can be started with as small as Rs 500 per month.
Why SIP?
The biggest advantage while investing through SIP is Rupee Cost averaging. With volatile markets, most investors remain skeptical about the best time to invest and try to ‘time’ their entry into the market. Rupee-cost averaging allows you to opt out of the guessing game. Since you are a regular investor, your money fetches more units when the price is low and lesser units when the price is high. SIPs may make the volatility in the market work in favour of the investor.
When should you start an SIP and for how long?
SIPs also help in availing benefits of compounding. This means, the earlier one starts an SIP, longer the investment horizon, larger the benefits. Reason being, each rupee once invested earns a return, now this return plus initial money adds up to earn a greater return, allowing your investment to grow at a faster pace. Higher rates of return or longer investment time periods increase the principal amount in geometric proportions. This is the most important reason for investors to start investing early and keep on investing on a regular basis to achieve the long-term financial goals.
SIPs provide the best path to disciplined savings. Discipline is the key to successful investments. When you invest through SIP, you commit yourself to save regularly. Every investment is a step towards attaining your financial objectives. However, with this disciplined approach, one also has the flexibility in investments. Although it is advisable to continue SIP investments with a long-term perspective, there is no compulsion. Investors can discontinue the plan at any time. One can also increase/ decrease the amount being invested.
So how to increase or decrease your SIP?
We use P/E ratio of Nifty 50 (proxy of market level) to determine whether to increase or decrease the SIP for that period. The Price to Earnings ratio or P/E ratio of an index is an indication of how high or low the market valuation of the benchmark index is. Higher the P/E, higher the valuation, and vice versa.
The P/E ratio is a great proxy for the amount of risk associated with a stock or an index. A higher P/E ratio means that the index is anticipating higher growth in the future, and people as a result, are taking higher risk.
The strategy helps you decide on your portfolio’s debt-equity asset allocation based on the current P/E. A higher P/E means that you should move some percentage of your upcoming SIP to debt instruments to reduce your risk, since market valuation is growing.
As the index moves away from higher P/Es, the strategy migrates your upcoming SIP more towards equity investments, since now you face lower risk and investments are done at a better Valuation.
We have described a strategy below that allows you to invest based on P/E which helps you divide your investments between Debt and Equity Mutual Funds to maximize your returns. We also call is Smart SIP.
Step-Up Investing, when the P/E is low, and Step-Down Investing when the P/E is high
Note: If your monthly base investment in Equity SIP is Rs 100,000/-, at the Maximum it will get scaled up to Rs 180,000/-, and at Minimum it will be scaled down to Rs 48,000/-
Four your understanding, this is how the average monthly P/E looks like in the past 20 years:
You might now ask – Why this basic P/E level?
We studied data of past 7 Years (1st July 2013 to 30th June 2020) and made few observations:
We observe that the P/E range of 21-24 is the band in which P/E level has spent its time more than any other band.
Coming to the return part, it might seem to be a little disappointing to you, but that is majorly because we are standing in the middle of a drought and looking back at the luscious green fields.
Let us see, how the same table looked like six months back from today (Data: 1st July 2013 to 31st December 2019):
Though the time spent by P/E in each band remains somewhat same but the return part changes drastically (especially at the higher PE level). Few of the numbers have shot up exponentially.
At the end, market will keep on giving us opportunities and P/E will be reverting back to its mean. We just have to keep on riding the curve and buy cheap (at lower valuations/PE). Here is how Nifty 50 and its P/E have behaved in past:
There is a reasonable (but not guaranteed) correlation between the trailing P/E and Nifty returns. And this study provides some useful insights. If we were to go by the historical data, the Nifty delivers higher return (in long-term) whenever investment is made at low P/E ratios. On the other hand, it tends to deliver low to negative returns whenever investment is made at high P/Es and when the investment horizon is short. You as an investor can use this insight as a backdrop to take your investments decisions.
Ask us for more details about Smart SIP. Minimize your risk and maximize return with buying cheap.
Happy Investing!