What is the 7-5-3-1 Rule in SIP?
This rule provides a broad framework based on historical average returns that investors might expect from mutual funds over specific durations. It helps set realistic return expectations when investing through SIPs. This rule emphasises the importance of investment tenure, diversification, mental strength, and incremental growth in SIP amount.Also Read | Global markets in meltdown mode. Should you pull out of Hang Seng, Wall Street funds?
7 – Patience is the key
This fundamental principle of the rule is to have a seven year investment horizon . Historic data shows that equities have performed well in the longer horizon and investing via SIP allows the power of compounding to take full effect.
The longer the investment horizon the more significant is the compounding effect. Investing in equity SIPs for a minimum of 7 years significantly improves the likelihood of achieving reasonable returns while also lowering the chances of experiencing negative returns.
5 – Diversifying the portfolio wins
For equity investors, diversification is the important thing to achieve stability and growth in the investment portfolios. The 5 finger framework suggests spreading investments across five asset classes to balance risk and reward. These asset classes include high-quality stocks, value stocks, growth at reasonable price (GARP) stocks, mid-or-small cap stocks, and global stocks.High-quality or large-cap stocks are the foundation of a strong investment portfolio as they have strong economic fundamentals and performance records. They provide stability during market downturns and help reduce portfolio volatility.
Value stocks are currently undervalued in the market and investing in them can be profitable over the long term, as they are likely to appreciate in value.
GARP stocks are promising companies in emerging or rapidly growing sectors. These combine elements of both growth and value investing.
Mid or small cap stocks represent companies with substantial growth potential. While they carry high risk but have the potential to deliver exponential returns.
Also Read | NFO Insight: Kotak Energy Opportunities Fund opens for subscription. Should you invest?
Global stocks allows investing having geographical diversification to a portfolio protecting it from local economic downturns and opens opportunities in the international markets offering a hedge against domestic risk and an opportunity to enhance overall portfolio performance.
3 – Mental strength
Equity investors often face three challenging phases that test the commitment towards their investment strategy and goals. Here is how to prepare for each phase:
The Disappointment Phase (7-10% returns) – Investors may anticipate high returns and feel let down by moderate gains. However, recognizing that even moderate returns signify forward movement and are integral to the investment journey can help manage expectations during this phase.
The Irritation Phase (0 -7% returns) – Investors might get frustrated, thinking fixed deposits would have delivered better returns. It’s important to understand that market ups and downs are natural, and SIPs are structured for long-term wealth creation rather than short-term comparisons
The Panic Phase (Negative returns) – A drop in portfolio value below the initial investment can trigger panic. However, it’s crucial to stay composed and resist the urge to sell. Markets tend to recover over time, and continuing with your SIP can help you benefit from the eventual rebound.
1 – Increase your SIP amount every 1 year
Increasing your SIP amount each year is like boosting the strength of your equity portfolio. It reflects a stronger commitment toward your financial goals and can help improve long-term outcomes. Understand why this strategy matters:
Reach your financial goals faster – Raising your SIP amount over time can speed up the achievement of your financial targets
Expanding financial goals – With experiencing the benefits of incremental growth, the financial aspirations may expand. One might start considering financial independence as a goal rather than solely focussing on building a retirement corpus.
The 7-5-3-1 Rule of SIP offers a strategic framework for investing, providing clear guidance for a successful equity investment journey.