It’s about decision points

Your SIP’s tenure could depend on the decision points or investment interventio

Systematic investment plan (SIP) creates a disciplined approach to accumulating wealth for achieving your life goals. But should the tenure of your SIP always be aligned to your goal? In this article, we discuss why the tenure of your SIP could also depend on how many decision points or investment interventions you require.

Decision points

Your investment decisions can either be automatic or conscious. After your initial decision to set up the SIP, the investment is made every month through an automatic debit to your bank account. Conscious decisions, on the other hand, are the ones that you deliberate upon each time you make an investment.

How do you determine whether you should apply the automatic or conscious mode to set up an investment? That would depend on what behavioural economists call decision points. Think of each conscious decision you take as a decision point. Now, creating decision points depends on whether your investment requires continual intervention. That is, do you have to review your investment periodically to decide whether to continue with your SIP?

Suppose you are investing to accumulate the down payment to buy a house. You could choose between an active fund and an index fund for your equity investments. Assume you choose an index fund. All index funds based on the NSE 50 Index will offer similar returns. You do not, therefore, need multiple decision points or investment intervention. So, you should set up an SIP on an index fund spanning the entire time horizon for your life goal.

Likewise, you can set up an SIP spanning the entire time horizon for your life goal if your bond investment is in the form of recurring bank deposit. This is because a recurring deposit does not require continual review, as the interest rate is fixed and you do not receive periodic cash flows from the bank.

Active interventions

You have to make a conscious decision to invest in active products. This would mean that you have to deliberate each month you make an investment in an active fund! But that may not be optimal for several reasons. One, you should review fund performance annually, not monthly. And, two, you need a process that automatically debits your bank account every month, as you may lack the discipline to make periodic investments.

So, how should you invest in an active fund? You should create multiple decision points. Why? Your objective is not just to accumulate down payment to buy a house. You have the additional objective of the fund having to beat its benchmark index and peers. Why else would you want to invest in an active fund?

Now, investing in an active fund exposes you to market risk and active risk. The latter is the risk that the fund manager could actually underperform the benchmark index and generate negative alpha. In addition, the fund’s ranking against its peers could also change every year.

Therefore, it would be optimal to set up an SIP on an active fund for not more than 12 months. If your objective were to buy a house 10 years hence, you would have created ten decision points or investment interventions. This means you will have the opportunity to deliberate ten times on whether to renew your SIP after reviewing the fund’s annual performance. The same argument applies for active bond funds.

Therefore, to conclude, you need one decision point for index funds and recurring deposits. You require a yearly intervention for active funds. Note that this intervention relates to buying decisions only. You may require multiple interventions to manage unrealised gains in your index fund too! We will leave this more complex topic for a later discussion.

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

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