Go beyond SIPs; now think about a Dynamic SIP…

Most mutual fund investors are aware of the benefits of a systematic investment plan (SIP). Firstly, an SIP allows you to spread your investment over a period of time and thus it enables you to capture the volatility in the market in the most effective way. Secondly, the concept of rupee cost averaging works in your favour as you tend to buy more when prices go down because of a fixed outlay on a regular basis. Last but not the least an SIP also brings about an investment discipline by nurturing a regular saving habit and aligning your investment profile more closely with your income profile.

But the standard SIP has its limitations…

Historical data supports the view that SIPs tend to outperform lump-sum investments over a longer period of time. However, a SIP tends to become rigid as the monthly allocation tends to be fixed over a period of time. Hence the SIP does not capture the benefits of a down market fully. The answer to this problem could be a Dynamic SIP. Let us understand the concept of a Dynamic SIP more elaborately.

Dynamic SIP tweaks the quantum of regular investment…

Dynamic SIP also adopts a systematic approach to investing and hence gets all the benefits of a traditional SIP. In addition a Dynamic SIP also varies the quantum of monthly investment based on certain pre-set rules. The logic here is that the investor allocates a higher sum when the markets are underpriced and allocates a lower sum when the markets are overpriced. However, overpricing and under-pricing becomes a subjective decision. Here is how the logic for a Dynamic SIP can be built by a mutual fund investor.

Use Index levels as a criterion for Dynamic SIP…

This is the simplest method of constructing a Dynamic SIP. The investor can create a Dynamic SIP based on the levels of the Nifty or the Sensex. Let us consider the current scenario. Over the last 18 months the Nifty has touched a high of 9122 and a low of 6850. The criterion can be crafted something like this. The monthly SIP can be kept at Rs.5,000/- if the Nifty is above 8500; Monthly SIP can be set at Rs.7,500/- if the Nifty is between 7500 & 8500; SIP can be further hiked to Rs.10,000/- per month if the Nifty goes below 7500 levels. This will ensure that automatically you end up allocating more when the Nifty is down and vice versa. This is a slightly more scientific technique of systematic investment compared to a traditional SIP.

Use Valuations as a criterion for Dynamic SIP…

This approach is a slight improvement over the Index Level based dynamic SIP. Here the criterion is not the level of the index but the P/E ratio of the Nifty as a whole. This is slightly superior to the previous method as the Index level is vulnerable to the movements in a handful of high weightage stocks. The valuation based method of dynamic SIP is superior as it is closer to the idea of allocating more money when stocks are cheaper. Here is how this can be put to work.

Over the last 18 months the Nifty has touched a peak of P/E ratio of 26 and a low of 16 on a rolling four quarter basis. The criterion can be crafted something like this. The monthly SIP can be kept at Rs.5,000/- if the Nifty P/E is above 22; Monthly SIP can be set at Rs.7,500/- if the Nifty P/E is between 18 & 22; SIP can be further hiked to Rs.10,000/- per month if the Nifty P/E goes below 18 levels. This will automatically ensure that you are buying more when markets are underpriced and less when markets are overpriced.

There are also some allocation funds offered by mutual funds which automatically tweak the allocations to equity based on their view on markets and interest rates. For example, when there is expectation of a rate cut, the fund automatically increases its exposure to long term government debt. The converse strategy is adopted when rates are expected to rise. In equities, the fund automatically allocates funds to cyclical stocks at lower valuations and to defensives at higher valuations. You can achieve the benefits of a dynamic SIP purely by designing a traditional SIP on these allocation funds. That surely is an easier way of doing it!

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