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The spread of financial literacy and digital banking in India over the last few years has completely changed the way ordinary citizens save and invest money. According to the latest data of the Association of Mutual Funds in India (AMFI), the investment coming in every month through Systematic Investment Plan (SIP) in the country has crossed the record level of Rs 20,000 crore to Rs 24,000 crore. From cities like Lucknow, the capital of Uttar Pradesh, Kanpur, Varanasi, Noida and Prayagraj to the youth living in Tier-2 and Tier-3 towns across the country, employees of private companies and small businessmen are now preferring mutual fund SIP over bank FD or traditional insurance schemes. However, the truth is that millions of people start SIPs, but as soon as the stock market falls or returns look negative for a few months, they panic and stop their SIPs. Financial experts believe that the game of wealth creation is not just about investing money, but about following the right rules and discipline. If you also want to achieve real financial freedom and create wealth worth crores of rupees through mutual funds, then the most popular ‘7-5-3-1’ rule of wealth management can prove to be the surest roadmap for you.
The first and most basic number of the ‘7-5-3-1’ formula of SIP is ‘7’, which simply means – investment horizon of at least 7 years in equity mutual funds. Often new investors consider the stock market as a ‘get rich quick’ scheme to become rich overnight and expect 20-30 percent returns in one or two years. But the equity market cycle does not always move in a straight line. If we analyze the historical data of the last 25 to 30 years of the Indian stock market (Nifty 50 and BSE Sensex), an amazing fact emerges. If an investor invests in an equity mutual fund for only 1 year, the chances of loss (negative return) are around 25 to 30 percent. The risk of loss reduces to around 10 percent over a period of 3 years. But as the investment period becomes 7 years or more, historically the probability of loss becomes almost zero (0%). In a 7-year cycle, the market absorbs both bear markets and bull markets and is able to deliver an average compound annual return (CAGR) of 12 to 15 percent. So the first lesson of this rule is that whenever starting an equity SIP, fix your mental timeframe to a minimum of 7 years.
The second important digit in the formula is ‘5’, which avoids the mistake of keeping your investments in a single basket. Just like the five fingers of a hand together make a strong fist, similarly the portfolio of a successful investor should be divided into at least 5 different categories. Many new investors, looking at the past returns of the last one year, invest all their money only in small-cap or any one thematic/sectoral fund, which causes huge losses when the market falls. The first component in an ideal portfolio of 5 funds should be a large-cap or Nifty 50 index fund, which provides stability by investing your money in the top 50 bluechip companies of the country. The second part should be of mid-cap funds, which consist of fast-growing mid-cap companies and they act as excellent growth engines in the long run. The third portion should be small-cap funds, which provide additional alpha and high-return potential to the portfolio. The fourth part should be of flexi-cap or multi-cap funds, where the fund manager has complete freedom to invest money in any sector as per the market conditions. The fifth and final part should be a hybrid fund, debt fund or multi-asset allocation (which includes gold and silver), which acts as a shock-absorber i.e. a safety net during heavy market falls.
The number ‘3’ represents the psychological journey of the market that every SIP investor inevitably has to go through. Many investors leave the field midway due to not understanding this third rule. The first stage is ‘Disappointment Phase’. When you start SIP and the market falls in the next 1 to 2 years, your portfolio starts looking in the red. You feel that your decision was wrong and you are losing money. But wise investors know that this is the time when most units are accumulated at the cheapest NAV in a falling market. The second stage is ‘Irritation Phase’. This phase usually comes between 3 to 5 years, when the market remains stuck in the same range for a long time (Sideways Market). During this period, your returns are only as much as in bank savings account or FD (6-7%). The investor starts thinking that despite taking so much risk, nothing special was achieved. After this comes the third and most magical phase – ‘Elation/Joy Phase’. After completion of 5 to 7 years, when the magic of compounding starts working, huge profits are recorded on the cheaper units raised earlier. In this third phase, your returns suddenly go up like a rocket and the interest every year starts becoming bigger than your principal.
The last and most powerful number of the 7-5-3-1 rule is ‘1’. It’s just a small task—step-up your SIP by at least 10% every year. Most of the working people start SIP of a fixed amount (say Rs 5,000 or Rs 10,000) and leave it as it is for 15-20 years. They forget that every year there is appraisal in their salary, business profits increase and inflation also increases. If you increase your SIP by just 10 per cent every year with your salary increase, it can result in your final corpus doubling or tripling.
Let’s understand the financial magic of this 1 little task with a simple math: Suppose you run a normal flat SIP of Rs 10,000 per month for 20 years at an average assumed return of 12%. In these 20 years, a total of Rs 24 lakh will be deposited from your pocket and at the rate of 12%, your total fund will be around Rs 99.91 lakh (approximately Rs 1 crore).
Now compare this with a 10% step-up: If you start with Rs 10,000 per month and add 10% to the SIP amount every year (ie Rs 11,000 per month in the second year, Rs 12,100 per month in the third year), your total investment in 20 years will be around Rs 68.75 lakh, but your maturity corpus will grow to around Rs 2.36 crore. That means, with just 1 small discipline, your final fund goes straight from Rs 1 crore to Rs 2.25 crore.
Along with creating wealth worth crores, it is also important for investors to have knowledge of income tax rules and the correct exit strategy. According to the amendments made in the Union Budget, profits on units held in equity mutual funds for more than 1 year are considered as Long Term Capital Gains (LTCG). Now long-term capital gains up to Rs 1.25 lakh per financial year are completely tax-free, while additional profits above Rs 1.25 lakh attract LTCG tax at the rate of 12.5 per cent. At the same time, if units are sold before 1 year, Short Term Capital Gains (STCG) tax has to be paid at the rate of 20 percent. Additionally, as you approach your 7 or 10-year financial goal—like a child’s higher education or retirement—you should use a ‘Systematic Transfer Plan’ (STP) instead of withdrawing the entire money in one go, 2 to 3 years before the goal. Under this, the money from equity funds should be gradually shifted to safe liquid funds, arbitrage funds or ultra-short term debt funds, so that even if there is a big crash in the stock market in the last year of the target, your hard-earned money of your life will be safe and you can fulfill your dreams without any stress.