Dynamic or standard SIP? – The Hindu

Gold prices have jumped more than 40% in one year. If you have been investing in a gold ETF through a systematic investment plan (SIP), think about this: You are investing the same amount of money despite the sharp increase in gold price. Is that optimal? In this article, we discuss whether you should tailor your SIP based on the market price of an asset.

Tailing the market

Critics of SIP have a point; investing the same amount despite a sharp increase in the asset price exposes your investment to huge downside risk, unless you take profits on a continual basis. The suggestion is to invest more when prices fall and cut the investment size when price increases. Such a dynamic SIP is meant to tail the market.

But to setup such an SIP, you need to consider several factors. One, the amount that you invest will vary on a continual basis. This could stress your current consumption because you may have to save and invest more in some months. Two, you must specify a cap (maximum) and a floor (minimum) that you will invest every month. Otherwise, you may have to invest large amounts of money when the market tanks.

And three, you may have to adjust the SIP amount manually, as asset management companies (AMCs) and brokerage firms may not offer such a facility. Is dynamic SIP worth the effort? It could be, if you can apply a rule-based process.

Suppose you expect 12% return on your investments every year, or 1% per month. Suppose your investment generates 4% this month. Then, you could invest 0.97 times the standard SIP amount. You earned three percentage points more than the expected return this month. So, you deduct three percentage points of excess returns from 1 to arrive at multiplier. And, if the return were 6%, you would invest only 0.95 times the standard SIP amount.

Conclusion

You must design a rule to setup a dynamic SIP and implement it consistently. Note an auto-debit may not work for such a custom-tailored rule. If you believe you will be unable to apply this process every month, you could setup a standard SIP with an add-on feature.

During months the market tanks, you can invest some lump-sum money in addition to your standard SIP. But you have to invest the standard SIP amount during months the market rises significantly.

(The author offers training programs for individuals to manage their personal investments)