How to simulate your SIPs against your long term goals

The safety of any SIP, most especially an equity SIP, is often questioned. However, the same level of security as a normal equity fund investment applies to an SIP. An added benefit of the SIP is Rupee Cost Averaging; it can lower the average cost per unit over time. Holding an equity SIP for longer gives short-term falls more time to recover, but there is no holding period over which a loss is ruled out. Obviously earning more than index returns requires further consideration; that is a separate discussion.

The big challenge is not about how SIPs perform, but rather how they help you reach your financial goals. Each SIP is usually linked to a particular objective and that’s how you can track your progress. Since financial objectives are heavily based on the future, there is an inherent level of uncertainty which needs to be managed. This means that simulations must form the basis of your SIP amount. To gain a better understanding of effective SIP investment tips and long term ideas, let us explore the best SIP for long term investment in India, and understand why simulation plays such an important role in deciding these amounts. We’ll take a look at 6 possible simulations ahead of beginning your SIP.

1. Simulating levels of income growth

You need to recognize that your SIP will be largely affected by changes in income. It should, therefore, not remain stationary and needs to be adjusted accordingly. While you may expect substantial growth over the course of your career, there can also be times when your earnings stagnate or take a dip. To maximize savings, it is recommended to divide your SIP into two parts: the core SIP (which should stay consistent) and satellite SIP (which should be flexible).

2. Simulating levels of expenditure growth

Projecting one’s expenditure carries two intriguing implications. Over time, both costs and quality of life will increase as spending habits adjust. When approximating long-term expenses after retirement, liabilities must be taken into account. The second and most important factor is the ability to save. Generally, people look at what is left over for savings; when simulating, it works the other way round, making sure that a target amount has been saved before estimating expenses, which can then be divided between core and satellite components as previously mentioned.

3. Simulating costs of goals

People often ponder over the cost of their objectives. From retirement to children’s education, long-term emergency corpus and more, one can only arrive at an approximate figure for these goals because most of them lie in the distant future. As time progresses and the cost of these aspirations become clearer, they may be adjusted accordingly.

4. Simulating rate of inflation

This is, in a way, part and parcel of your cost simulations. Inflation is the rate at which costs will rise. You should be as liberal as possible here to ensure that incidental expenses are covered. As an example, if the current inflation rate is 5% and the average inflation rate was 6% in the past, then two scenarios of 6% and 7% inflation would be ideal to prepare in case of any exigency or macro shock.

5. Simulating return on debt investments

This fascinating simulation involves a plethora of absorbing assumptions. For instance, the returns on debt are contingent upon various parameters, primarily the level of interest rates, direction of interest rates, and inflation. When interest rates plunge, bonds typically become more valuable – conversely when they rise, their worth diminishes. On top of this, corporate debt earns different spreads over G-Secs and “AA” rated debt in comparison to “AAA” rated debt. All of these variables will ultimately decide how much profit you can generate from your investments and therefore how to combine them effectively.

6. Simulating return on equity investments

This part of it is a bit complicated. Interest rates may be easier to extrapolate than equity rates. But there are some pointers. Firstly, there is a simulation of mid caps versus large caps returns. Second, there is a simulation of equity returns. For example, you might assume an annual return for equities in your simulation; historical returns vary widely by period and are not a guide to future returns.

Simulating involves analyzing how your SIP aligns with your goals under different scenarios. The more scenarios you simulate, the better prepared you are for any situation.