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Investment tip: How long should you run an SIP?

· Business

It's a question that vexes 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 SIP continues and is useful in a way to keep investing without bothering to actually take the time out and do it.

However, occasionally, the SIP investor gets a large sum of money at one go. It could be a bonus from a workplace, or it could be proceeds from the sale of some asset like real estate, or it could even be your retirement kitty which you need to spread and make it last for the rest of your life. Investing in an equity-backed mutual fund is the best way to get great returns over a long period like 5-7 years or more. However, over shorter periods, equity funds are dangerous. And when you invest at a large sum at 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%. 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 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 enhance the returns you will get. That is of course, the standard set of advantages that a SIP has. However, the vexing question is what is this 'certain period'? Is it six months? One year? Two years? Or even longer? There are arguments for and against.

Last week, I wrote about the research project on historic SIP returns that Value Research has carried out and we saw how SIP was truly safe for about four years and above. In this study, we found that on an average, if you invest in a 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 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, maximum is 30% and minimum 13% .These is all annualized figures. The trade-off is crystal clear--the shorter the period, the higher the potential gain but the worse the possible risk.

The answer from this data appears to be that SIPs must last more than three years. 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, it would be ridiculous to spread it over 3-4 years.

If you have sold some ancestral property and the sum realized will be the core of your old age income, then you need to be cautious about the risk you take. In a case like this, you would do well to forego some potential income to ensure that you don't make a loss. A 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 4-5 years. So annual bonus could be invested in six months, while 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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