Individuals constantly look for strategies to generate money that will minimise their risk of loss while offering them steady returns over an extended period of time. One of the simplest and most efficient methods to build wealth is to invest the money you’ve saved in securities that may yield periodic returns. If you have stock SIPs or are considering investing in them, you may significantly boost your return potential by adhering to the 7-5-3-1 SIP rule. This rule has been tried and tested and is supported by a thorough historical investigation.
What is the 7-5-3-1 SIP Rule?
The 7-5-3-1 rule is a comprehensive strategy for maximising the benefits of Systematic Investment Plans (SIPs) in equity mutual funds. This rule emphasises the importance of investment tenure, diversification, mental fortitude, and incremental growth in SIP amounts. Below is a detailed explanation of each component of the rule.
7: Patience Is The Key
The first fundamental principle of the 7-5-3-1 rule is to have a 7+ year investment time horizon. Historical data analysis shows that equities tend to perform well over a seven-year period, averaging out losses incurred during market downturns. Investing in equity SIPs with a minimum of seven years allows the power of compounding to take full effect.
Compounding, similar to a snowball gathering more snow as it rolls downhill, means that the interest earned is added back to the principal amount, resulting in higher returns over time. The longer the investment period, the more significant the compounding effect, with seven years being the minimum ideal time for this financial magic to manifest.
5: Diversification Wins
For equity investors, diversification is crucial to achieving stability and growth in their investment portfolios. The 5 Finger Framework suggests spreading investments across five key asset classes to balance risk and reward effectively. These asset classes include high-quality stocks, value stocks, GARP (Growth at Reasonable Price) stocks, midcap or small-cap stocks, and global stocks.
- High-Quality Stocks (Large Cap Stocks): High-quality or large-cap stocks form the foundation of a robust investment portfolio. These are stable, well-established companies with strong economic fundamentals and performance records. They provide stability during market downturns and help reduce portfolio volatility, although they may offer lower returns than smaller, more volatile stocks.
- Value Stocks: Value stocks are currently undervalued in the market. Investing in these stocks can be profitable over the long term, as they are likely to appreciate in value, allowing investors to sell them at higher prices.
- GARP Stocks (Growth at Reasonable Price): GARP stocks are promising companies in emerging or rapidly growing sectors. These stocks combine elements of both growth and value investing. Sectors like drones and telecommunications in India are examples of areas where GARP stocks can be found, offering the potential for significant future growth.
- Midcap or Small Cap Stocks: Midcap and small-cap stocks represent companies with substantial growth potential. While they carry higher risks than large-cap stocks, they can deliver exponential returns. Some small-cap mutual funds, for instance, have provided returns exceeding 60% in a single year, reflecting their growth potential.
- Global Stocks: Investing in global stocks adds geographical diversification to a portfolio, protecting it from local economic downturns. It also opens up opportunities in international markets, offering a hedge against domestic risks and enhancing overall portfolio returns.
3: Overcoming Mental Fights
Equity SIP investors often face three challenging phases that can test their commitment to their investment strategy. Here’s how to mentally prepare for each phase:
- Disappointment Phase (7-10% Returns): Investors might expect higher returns and feel disappointed with moderate gains. Understanding that moderate returns are still positive progress and a part of the investment journey will help prepare for this stage..
- Irritation Phase (0-7% Returns): Investors may feel irritated, believing fixed deposits could have yielded better returns. Recognise that market fluctuations are normal and that SIPs are designed for long-term growth beyond short-term performance comparisons.
- Panic Phase (Negative Returns): Seeing the portfolio value dip below the initial investment can cause panic. Stay calm and avoid panic selling. Remember that markets recover overtime, and maintaining the SIP can lead to eventual gains.
1: SIP Growth For Better Returns
Increasing the amount of your Systematic Investment Plan (SIP) annually is similar to enhancing the capacity of your equity portfolio. By doing so, you are making a greater effort to achieve better results. Let’s understand why this strategy matters:
- Reach Financial Goals Faster: Incrementally increasing your SIP amount accelerates your journey towards financial goals. For instance, if you aim to save for a down payment on a 3 BHK apartment instead of a 2 BHK, increasing your SIP contributions each year can help you achieve this target within the same time frame.
- Expanding Financial Goals: As you experience the benefits of incremental growth, your financial aspirations may expand. You might start considering financial independence as a goal instead of focusing solely on building a retirement corpus.
Consider a hypothetical example:
- Normal SIP: You start with an SIP of ₹5,000 per month and do not increase it annually. Over 25 years, you would accumulate approximately ₹1.64 crore. This amount is equivalent to ₹34 lakh in today’s terms.
- Step-Up SIP: You start with a SIP of ₹5,000 per month and increase it by 10% each year. Over 25 years, you would accumulate approximately ₹2.81 crore. This amount is equivalent to ₹58 lakh in today’s terms.
Imagine your bank account has a fixed deposit worth ₹34 lakhs. Now, consider how it would feel if this ₹34 lakhs grew to ₹58 lakhs just by adjusting your SIP contributions annually.
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Conclusion
The 7-5-3-1 Rule of SIP embodies a powerful approach to investing. With its comprehensive guidance, the rule illuminates the path to a rewarding equity investment journey. As we look ahead, the future of equity investing appears promising, brimming with potential for those who embrace its principles. Now that you have learned the 7-5-3-1 Rule of SIP, start investing with confidence. Open your Demat account today with Angel One and start investing!
FAQs
Can the 7-5-3-1 rule be customised to individual investment preferences?
Yes, investors can tailor the rule to align with their risk tolerance, investment objectives, and financial aspirations by adjusting SIP amounts and asset allocations accordingly.
What are the potential benefits of following the 7-5-3-1 rule?
Following the rule may lead to enhanced portfolio growth, increased resilience to market volatility, and a greater likelihood of achieving long-term financial goals.
How can investors implement the 7-5-3-1 rule effectively?
Investors can implement the rule by maintaining a long-term investment horizon, diversifying their portfolio, staying resilient during market fluctuations, and increasing SIP amounts annually.
How does diversification play a role in the 7-5-3-1 rule?
Diversification spreads investments across high-quality stocks, value stocks, GARP stocks, mid or small-cap stocks, and global stocks, balancing risk and reward effectively.
