SIPs: The Basics
Systematic Investment Plans (SIPs) are a convenient way to invest regularly, often aligning with life goals like retirement or education. However, the
approach differs significantly depending on the type of fund. While SIPs on index funds or ETFs can often be set up for the entire duration of a goal (e.g., eight years for an eight-year goal), active funds demand a different strategy. The goal of an active fund investment is to achieve positive alpha, thus, it is crucial to evaluate its performance periodically. This is crucial for maintaining alignment with investment objectives.
Annual Performance Reviews
The cornerstone of managing SIPs in active funds lies in annual performance reviews. The primary reason for annual reviews is that you invest in an active fund with the expectation of earning positive alpha. This means you are anticipating that the fund manager will outperform the market. Therefore, assessing the fund’s performance on an annual basis is a necessity to determine if the active fund is delivering on its promise. By doing so, you can gauge whether the fund’s returns align with your expectations and whether it is contributing effectively towards achieving your life goals. Each year, it is also recommended to statistically test the risk-adjusted return (Sortino Ratio) of your investments in active funds to assess its performance objectively.
12-Month SIP Strategy
Given the need for annual evaluation, the most effective approach for setting up SIPs in active funds is to structure them for 12-month periods. This strategy allows for a comprehensive review of the fund's performance each year. At the end of each 12-month cycle, investors can make informed decisions based on the fund’s results. For instance, if the performance is satisfactory, the SIP can be renewed for another year. Even if you are not entirely pleased, you have the option to renew, staying with the fund for another period. Alternatively, you can choose to switch to another active fund or even transition to a passive one, such as an index fund or ETF.
Making Informed Choices
At the conclusion of each 12-month SIP cycle, investors must evaluate their choices concerning their active fund investments, bearing in mind the remaining time horizon for their life goal. There are several decisions you might consider. If you are pleased with the fund’s performance, renewing the SIP for an additional 12 months is a straightforward choice. However, if the performance doesn't meet your expectations, you still have the option to renew the SIP and stay invested for another year, if you believe in the fund's long-term potential. Otherwise, investors can either switch to a different active fund that may offer better prospects, or they can opt for a passive fund.
Transitioning to Passive Funds
If you decide to transition from an active fund to a passive fund, the strategy for SIPs shifts. With a passive fund, such as an index fund or ETF, you can align the SIP with the remaining time horizon for your life goal. For instance, if you initially set up a SIP for an eight-year goal and have completed three years with an active fund, you can set up a SIP for the remaining five years with a passive fund. This approach aligns with the core philosophy of passive investing, where the focus is on mirroring the market’s performance rather than trying to beat it. When transitioning, make sure to consider factors like expense ratios and fund tracking to make the most informed decision.
Aligning with Goals
The primary objective of any investment strategy should be to align your investments with your life goals. Through the use of active funds, the approach has an emphasis on the assessment of performance at yearly intervals to gauge how the fund is helping you achieve your aims. By regularly monitoring and adjusting your SIPs based on fund performance and market conditions, investors can ensure that their investments are on track to meet their financial objectives. This proactive approach helps in managing risk and optimizing returns over time, providing a clear path to achieve life goals.
