How to make the most of your equity SIP investments? Decoding 7-5-3-1 rule

The last 43+ years of Sensex journey shows that - temporary market falls of 10-20% happen almost every year and 30-60% falls can be expected once every 7-10 years.

In order to make the most of your equity SIP investments, mentally prepare to continue investing for at least seven years and diversify your equity portfolio across five different investment strategies, says  FundsIndia in a note.

 

"Different investment styles, market cap segments and geographies do well during different market phases. Hence it becomes important to diversify across them. You can diversify your Equity SIP portfolio equally across - 1) Quality 2) Value 3) Growth at Reasonable Price 4) Mid / Small cap and 5) Global," said Arun Kumar, Head Mutual Fund Research at FundsIndia.

 

When it comes to equity investing, there’s no magic formula to guarantee success, but a structured approach can significantly improve your chances. One such framework is the 7-5-3-1 Rule, a simple yet powerful strategy designed to help investors get the most out of their Systematic Investment Plans (SIPs) in equities, noted the report. 

 

 By following this rule, you can increase your chances of superior long-term returns and navigate the ups and downs of the stock market with confidence. Here’s how the 7-5-3-1 Rule can guide you on your investment journey.

 

What is the 7-5-3-1 Rule?

The 7-5-3-1 Rule breaks down the approach into four key components:

 

7+ Years Investment Timeframe

• Diversify Across 5 Strategies
• Prepare for 3 Common Investor Challenges
• Increase Your SIP Amount by 1% Every Year

 

Let’s take a closer look at each of these principles.

1. Have a 7+ Year Investment Timeframe

Historical data shows a seven-year investment horizon significantly reduces the likelihood of negative returns and improves the odds of achieving reasonable, even high, returns. 

 

Why 7+ Years?

• No Negative SIP Returns Over 7 Years: Looking at the Nifty 50 Total Return Index (Nifty 50 TRI) over the last 23 years, there has been no occurrence of negative SIP returns over a 7-year period.
• Low Occurrence of Mediocre Returns: Only 4% of the time, returns were lower than 7% annually.
• Higher Chances of Strong Returns: On average, 80% of the time, returns were greater than 10% annually.
• Even during rare instances when returns were below 10% due to sharp market declines, extending the investment period by just a year or two often led to significant recovery in returns.

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As seen below in the table provided by FundsIndia, even for the rare 7Y periods where Nifty 50 TRI SIP returns were  below 10% due to a sharp market fall (in the final years), extending the time frame by 1-2 years led to sharp recovery in returns.  

 

2. Diversify Your Equity Portfolio Across 5 Strategies

Equity markets go through cycles, and different types of stocks or strategies perform well during different phases of these cycles. To ensure that your portfolio is prepared for all market conditions, it’s essential to diversify across multiple strategies.

 

Here are five key strategies you should include in your portfolio, as per FundsIndia

• Quality Stocks: Stable, well-established companies with a proven track record of performance.
• Value Stocks: Undervalued companies that are trading below their intrinsic value, with strong growth potential.
• Growth at Reasonable Price (GARP): Companies with good growth prospects but available at reasonable valuations.
• Mid/Small-Cap Stocks: High-growth potential companies that are smaller in size but may provide high returns over time.
• Global Exposure: Invest in international markets to diversify risks and take advantage of growth in different regions.

 

3. Prepare for 3 Common Phases of Equity SIP Investing

Investing in equities through SIPs is not a smooth ride—it’s a journey with ups and downs. Every investor will face certain "pain phases" at some point during their investment horizon.Kumar explains what you should mentally prepare for:

 

The Disappointment Phase: This is when you start your SIP and expect higher returns, but initially, you see returns that are only slightly above fixed deposit (FD) returns (7-10%). It’s a tough pill to swallow, but it’s common in the early years of equity investing.

 

The Irritation Phase: At this stage, returns might be even lower than FD returns (0-7%), and you might start questioning if equities are worth the risk.

 

The Panic Phase: The worst phase for many investors, where the value of your investment falls below the amount you initially invested. This often happens during market downturns.

 

These phases happen because the stock market is prone to regular temporary declines—10-20% drops occur almost every year, and 30-60% corrections can happen once every 7-10 years. The key here is staying the course.

 

4. Increase Your SIP Amount Every Year

One of the most powerful ways to accelerate your wealth-building through SIPs is to increase your SIP amount every year. Even small annual increases can have a huge impact on your final corpus.

 

Why Increase Your SIP Amount?

By increasing your SIP contribution by just 10% every year, you can almost double your final amount after 20 years, assuming an annual return of 12%. This is because you are compounding both the growth of your initial investment and the incremental amounts you add every year, said Kumar.

 

For example, a Rs 10,000 SIP that you increase by 10% annually can grow to a much larger corpus over the long term compared to one where the SIP amount remains constant.

 

The below table by FundsIndia Research shows the difference in final amount across different time frames for different annual increases in SIP amount.