Create a diversified portfolio with SIP investments

Posted On: 21 September 2023

In the world of mutual fund investments, a strategy that stands out for its simplicity and effectiveness is the Systematic Investment Plan (SIP). Investing in an SIP offer investors an opportunity to create a diversified portfolio with a relatively better return potential over the long term.

In this article, we will understand the art of creating a diversified portfolio using SIP investments, and why seeking the guidance of a financial advisor is vital to succeed in the financial markets.

Table of contents

Meaning of Systematic Investment Plan (SIP)
Understanding diversification in SIP investments
Advantages of Using SIPs for portfolio diversification
Steps to build a diversified SIP portfolio
Tips to optimize your portfolio with SIP in mutual funds

Meaning of Systematic Investment Plan (SIP)

Before we discuss the importance of a diversified portfolio, let's grasp the essence of SIPs.

A Systematic Investment Plan (SIP) is an investment approach that allows you to invest a fixed amount regularly, typically on a monthly basis, in mutual funds. SIPs bring discipline to your investment journey and are the ideal choice for both beginners and seasoned investors.

Moreover, SIPs promote the habit of regular saving and investing. By consistently investing a fixed amount, you can also reap the benefits of power of compounding, which can work wonders over time. An SIP calculator can help you understand how your investments can potentially grow over time, helping you make more informed investment decisions. The tool is easy to use and requires you to simply input your investment amount, horizon and expected returns. Based on this, it will project the potential size of your final corpus. However, the calculator assumes a fixed rate of returns, based on your inputs, for its estimates. In reality, returns are not guaranteed and may fluctuate based on market movements.

Understanding diversification in SIP investments

Diversification is a key strategy in investment, including Systematic Investment Plans (SIPs), where you spread your investments across different asset classes, sectors, and geographies. This approach helps reduce risk by ensuring that your portfolio isn’t reliant on the performance of a single asset or market segment. In SIPs, diversification can be achieved by investing in a mix of equity, debt, and hybrid mutual funds. For example, an investor can allocate SIPs across large-cap, mid-cap, and small-cap equity funds, along with debt funds to balance risk.

Diversification reduces the impact of market volatility on your overall portfolio. While some assets may underperform in certain market conditions, others might perform relatively better, thus potentially stabilizing returns. By diversifying through SIPs, you also mitigate the risk of potential losses and increase your chances of consistent long-term growth. This strategy allows investors to stay aligned with their financial goals, regardless of market fluctuations.

Key aspects of diversification in SIPs:

Asset class diversification: Invest across different asset classes such as equity, debt (bonds, fixed-income securities), and gold. Diversify your equity investments across large-cap, mid-cap, and small-cap funds.

Sectoral diversification: Avoid focusing on one sector. Consider funds from varied sectors like technology, healthcare, financials, and consumer goods.

Geographic diversification: Explore international funds for broader geographic diversification.

Fund manager diversification: Spread your investments across multiple fund houses to benefit from diverse investment strategies.

Advantages of Using SIPs for portfolio diversification

An SIP makes investing convenient, consistent and affordable, as it allows you to invest an amounts that you are comfortable with at a frequency that suits you. Here are some of the benefits of SIP.

Rupee-cost averaging SIPs enable you to buy more units when the market is down and fewer units when it's up, thus averaging your purchase cost over time.

Compounding effect Your money earns returns, which are reinvested. This leads to compounding and the longer you stay invested, the more substantial the effect becomes.

Flexibility: This means that the fund manager can decrease and increase exposure to equities as per the market conditions in order to capture potential gains and reduce the impact on capital invested.

Convenience SIPs are hassle-free and can be tailored to your budget, making them accessible to a wide range of investors.

Now, let's move on to the crux of the matter— how to create a diversified portfolio with SIP investments

Steps to build a diversified SIP portfolio

Diversification is a fundamental strategy in the world of investments. It involves spreading one’s investments across various asset classes, sectors, and geographies. The primary aim is to reduce risk by not putting all your eggs in one basket.

Here's how you can achieve diversification through investing in SIPs:

Make a plan: Determine your investment goals, time horizon, and risk tolerance. This will guide your asset allocation and fund selection. For instance, risk-averse investors or those saving up for a short-term goal may need a relatively stable avenue such as debt mutual funds. Aggressive investors or those with a long investment horizon may benefit from equities.

Identify asset classes: Asset allocation is the foundation of diversification. It involves distributing your investments across different asset classes like equity, debt, and hybrid funds. Equity funds have the potential for better returns but come with a relatively higher risk. Debt funds are comparatively stable and offer lower returns. Hybrid funds combine both equity and debt components. Thus, your allocation should align with your risk tolerance and financial goals.

Select fund categories: Within each asset class, choose a fund category based on your goals, risk appetite and horizon. For example, equity investors can choose between large-cap, mid-cap, flexi-cap or small-cap funds, among other options. Debt investors can choose between short-term, medium-term, and long-term securities.

Select funds: Once the fund category has been identified, select a scheme. Avoid chasing the "best" mutual fund, as it's impossible to predict future performance. Instead, opt for well-established funds with a reputed Asset Management Company.

Diversify across sectors: Look at the portfolio holdings of the scheme you are considering to ensure it is adequately diversified. For instance, you may want an equity fund that is diversified across sectors. This can mitigate impact on the portfolio from the adverse effects of a downturn in a particular sector.

Constructing a diversified portfolio can be a complex task, especially if you are new to investing. Diversification is not a one-time task; it requires periodic review and adjustments as your financial situation evolves. Always keep in mind that while investing in SIPs can be a fantastic tool, consulting a financial advisor or distributor is a wise decision to navigate the intricate world of investments effectively. Building wealth is a journey, and with SIPs and diversification, you can create a sturdy foundation for a financially secure future. One way to enhance your investment strategy is through a top up SIP. This facility enables you to automatically increase your SIP contributions by a fixed percentage at regular intervals. Over time, this can potentially result in higher growth than a regular SIP. A top up SIP calculator can help you visualise this.

Tips to optimize your portfolio with SIP in mutual funds

Consistent investments: One of the crucial aspects of optimising your portfolio with SIPs is consistency. Regularly investing a fixed amount irrespective of market conditions helps average out the purchase cost, leading to potentially better returns in the long run.

Choose fund wisely: Select mutual fund schemes that align with your financial goals, risk tolerance, and investment horizon. Diversify your portfolio across various funds to spread risk.

Increase SIP amounts over time: As your income grows or when you have surplus funds, consider increasing your SIP amount. Incrementally raising investments in SIPs can accelerate wealth creation.

Long-term approach: Financial problems can arise anytime. However, with SIP investment if you tend to withdraw or redeem the returns early, you will not be able to build much corpus. Besides, if you're exiting from the SIP plan at a time when the market is low, your portfolio value will be lower, and will translate to lower returns. Hence, a long-term approach is recommended from getting the most out of SIPs.

Monitor and rebalance: Periodically review your SIP portfolio's performance. Rebalance the portfolio if needed by reallocating investments among funds or adjusting SIP amounts based on changing circumstances.

Read Also: 6 Ways to Reduce Risk in Your Investment Portfolio

Conclusion

In conclusion, SIP investments provide an avenue for potential wealth creation over long term through diversification. By strategically allocating your investments across asset classes, and sectors. You can achieve relatively reasonable returns with commensurate risk. Remember, the key to a successful diversified portfolio is not about chasing the “best” funds or predicting market trends but making informed choices that align with your financial objectives. Using tools like a Compounding Calculator can help you understand the impact of compounding on your investments, which can lead to better financial planning.

FAQs

What is an SIP, and how does it help in diversifying a portfolio?

A Systematic Investment Plan (SIP) is a way to invest in mutual funds regularly. It aids diversification by allowing you to invest small amounts in a mix of mutual funds, including equity, debt, and hybrid, thereby spreading your risk across different asset classes.

Should I focus on equity, debt, or hybrid SIPs for diversification?

The choice depends on your risk tolerance and financial goals. Equity SIPs offer growth potential but come with relatively higher risk, while debt SIPs provide relative stability. Hybrid SIPs combine both. Diversification often involves a mix of these based on your investment objectives.

How frequently should I review and rebalance my SIP portfolio to maintain diversification?

Regularly monitor your SIP diversified portfolio, at least annually. Rebalance if your asset allocation deviates significantly from your target. Keep in mind your financial goals and risk tolerance when making adjustments.

What is the ideal number of funds for a diversified SIP portfolio?

A diversified SIP portfolio typically includes 4-6 funds, combining equity, debt, and hybrid funds. This balance helps spread risk across asset classes while avoiding overconcentration in any single fund, providing relatively better growth potential and relative stability.

Can I diversify with SIPs on a small budget?

Yes, SIPs allow you to invest small amounts regularly, making diversification accessible even with a limited budget. By choosing funds that align with your risk profile and goals, you can diversify your portfolio without needing large initial investments.

How often should I review my SIP portfolio?

You should review your SIP portfolio at least once every 6 months to ensure it aligns with your financial goals, risk tolerance, and market conditions. Regular reviews allow adjustments in fund selection, asset allocation, and performance tracking.

Is SIP a good option for beginners to diversify investments?

Yes, SIPs are a suitable choice for beginners to diversify investments. They provide a simple, disciplined approach, allowing gradual exposure to various funds. SIPs help mitigate risks through rupee cost averaging and offer long-term growth opportunities.

How to create own SIP portfolio?

To create your own SIP portfolio, assess your financial goals, risk tolerance, and investment horizon. Choose a mix of equity, debt, and hybrid funds to balance risk and return. Start with small, regular investments and adjust based on performance

Mutual Fund investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.