Set your goal, start the SIP

The maturity of your monthly SIP should be aligned to the time horizon for your life goal

We typically spend most of our income, and then regret our spending decisions, especially when we need money to achieve our life goals! In this article, we discuss why you should set-up systematic investment plans (SIPs) to strike a balance between your spending and savings decisions. We also show you how to create SIPs to help you achieve your life goals.

Why set-up SIPs?

You and I suffer from what behavioural psychologists call “present bias”. This refers to our marked preference to enjoy life today at the expense of suffering the consequences in the future. Why is that so?

An important reason is delayed feedback. If you eat tasty-but-unhealthy food today, you enjoy the experience momentarily. But what if you eat healthy-but-not-so-tasty food instead? You do not reap the benefits till you are old. Likewise, spending today brings you happiness now. Saving for the future only gives you happiness in the future. Now, current happiness is much better than future happiness. So, spending today feels much better than saving for the future!

It is in this context that SIPs comes in handy. One way to overcome the present bias is to set up a mechanical savings process, whereby the bank or a mutual fund transfers a portion of your current income every month to your preferred investment products. That is not all. SIP also helps overcome inertia. How? Given the mechanical process, you do not have to take effort to save each month. This process also significantly reduces regret that comes when you actively take decisions. Besides, you distance yourself from your investment decisions. So, you reduce the confusion in your brain that you experience each time you have to decide between spending and savings!

An important secondary effect of setting-up a SIP is that savings is not a residual process, but the first step you take every month. Allow us to explain. If you do not set-up a SIP, you will, perhaps, spend your current income first and then save what remains. This makes it difficult for you to achieve a life goal. But if you set-up a SIP, the mutual fund or the bank will take out a pre-determined amount of savings from your account. This process helps you moderate your bias towards spending. Remember, your expenditure otherwise typically rises to meet your income!

Now that we have seen the behavioural reasons to create SIPs, the question is: How should you set-up a SIP?

How to SIP

You should set-up your SIPs such that the automatic debits happen on the day your salary is credited into your bank account. You should set-up a monthly SIP on an equity index fund and on a recurring bank deposit as part of your core portfolio to meet each of your life goals. The maturity of your bank deposit should be aligned to the time horizon for your life goal. You can also have a SIP for your real estate investment! The EMIs that you pay on your mortgage essentially amount to systematic investments on your real estate.

Finally, remember this: You should set-up SIPs only on passive investment products such as index funds and bank deposits.

Do not set-up a SIP on active funds! You should manually invest each month in active funds. Why? Your objective to invest in an active fund is to beat the market. But active funds may not consistently perform well against their benchmarks and peer funds. You should, therefore, continually review active funds.

By setting up SIPs on active funds, you distance yourself from your investment decision. That is typically good for goal-based passive investing, not for active investing.

The writer is the founder of Navera Consulting. Send your queries to portfolioideas@thehindu.co.in

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