What is 7-5-3-1 Rule in SIP Mutual Fund Investment?

It is true that most investors today are aware of investing in mutual funds through a Systematic Investment Plan (SIP) as it is one of the most effective ways to potentially build wealth over time. Yet, many investors still struggle with deciding how to structure their investments for optimal returns. This is where the 7-5-3-1 rule in SIP mutual fund investment comes into play.

This rule provides a simple yet effective approach to investing, focusing on patience, diversification, emotional discipline and long-term growth potential. By following this strategy, investors can balance out market fluctuations and optimize their returns in the long run.

In this article, we will explore the 7-5-3-1 rule in SIP mutual fund investment in detail, breaking down each element and explaining how it can help investors achieve financial success.

• Table of contents

• Explaining 7-5-3-1 SIP rule
• 7: Patience is the key
• 5: Diversification wins
• Why is diversification important?
• Tips to diversify your mutual fund SIP investments
• Overcoming the 3 main mental fights
• 1: SIP growth for optimal returns

Explaining 7-5-3-1 SIP rule

The 7-5-3-1 Rule in SIP mutual fund investment is a structured guideline that helps investors make disciplined and well-informed decisions. It consists of four key principles:

• 7 – Stay invested for at least 7 years to reap the benefits of compounding and market growth.
• 5 – Diversify your investments across at least 5 different mutual fund categories to reduce risk.
• 3 – Overcome the 3 main emotional biases and short-term fears by maintaining a long-term perspective.
• 1 – Increase your SIP investments every year for relatively better return potential in long term.

This rule encourages investors to stay patient, spread their risks, control their emotions and let their investments grow for long-term financial success.

Now, let’s dive deeper into each part of the 7-5-3-1 Rule in SIP Mutual Fund Investment and understand its significance.

Also Read: SIP for Long-term wealth creation

7: Patience is the key

The first principle of the 7-5-3-1 Rule in SIP Mutual Fund Investment emphasises the importance of staying invested for at least 7 years. Here’s why:

• Power of compounding: Mutual funds generate wealth over time through the power of compounding. The longer you stay invested, the more your returns grow exponentially.
• Market cycles: The stock market goes through ups and downs. A seven-year period gives enough time to recover from short-term market fluctuations.
• Reduced impact of volatility: Short-term market corrections are common, but long-term investing smoothens out these fluctuations and enhances overall returns potential.
• Wealth creation potential: Investors who remain committed for a longer duration are more likely to achieve their financial goals, such as retirement planning or buying a house.

Many investors panic during market downturns and withdraw their investments early, missing out on future gains. By following the 7-year rule, you allow your investment to grow and benefit from market recoveries.

5: Diversification wins

The second principle of the 7-5-3-1 Rule in SIP Mutual Fund Investment highlights the importance of diversification. Investors are advised to spread their investments across at least five different mutual fund categories to reduce risk.

Why is diversification important?

• Mitigates risk: If one sector or asset class underperforms, other investments can balance the losses. Also, a well-diversified portfolio may ensure that you benefit from different market opportunities.
• Mitigates impact of market volatility: Investing in various asset classes helps maintain stability, even during market downturns.

Tips to diversify your mutual fund SIP investments

• Equity funds: Invest in large-cap, mid-cap, and small-cap funds for balanced growth.
• Debt funds: Add some debt funds for stability and relatively lower risk.
• Hybrid funds: These funds combine equity and debt to offer moderate risk with decent returns potential.
• Sectoral or thematic funds: Invest in specific sectors such as technology, healthcare, or banking for higher potential growth.

By following the 5-fund diversification rule, investors can build a strong portfolio that performs well across different market conditions. Usually, the recommended investment spread is across quality stocks, value stocks, growth stocks, mid/small cap, and global stocks.

Overcoming the 3 main mental fights

The third element of the 7-5-3-1 Rule in SIP mutual fund investment is about controlling the 3 main emotions that often come into play and staying committed to your investment plan. Investing in mutual funds requires patience and discipline. However, many investors face 3 psychological challenges such as:

• Disappointment
• Frustration
• Panic

These emotions can lead to flawed decisions during market turmoil and adversely affect long-term portfolio outcomes.

• Fear of market crashes: Many investors panic when the market falls and exit their investments too soon.
• Greed during market highs: Some investors increase investments when the market is at a peak, only to suffer losses later.
• Short-term thinking: Impatience leads to frequent buying and selling, reducing overall returns.

Ways to overcome emotional biases

• Stick to your SIP plan: Do not stop your SIP investments during market downturns. Instead, take advantage of lower prices.
• Avoid timing the market: No one can predict the stock market perfectly. Stay invested and let time work in your favour.
• Revisit your goals: Focus on long-term objectives rather than reacting to short-term market movements.
• Seek professional advice: If you struggle with investment decisions, consult a financial advisor for guidance.

1: SIP growth for optimal returns

The final element of the 7-5-3-1 Rule in SIP Mutual Fund Investment focuses on increasing your SIP contributions every 1 year. Even a small annual increase can make a huge difference to your eventual corpus over the long run. Moreover, it is important to increase your SIP contributions to match your evolving financial profile.

Why should you let your SIP grow?

• Compounding benefits: The longer your investment stays, the higher the returns potential due to compounding.
• Tax efficiency: Long-term investments in equity mutual funds attract lower capital gains tax.
• Financial freedom: By staying invested and letting your SIPs grow, you can achieve major financial goals like homeownership, child’s education or retirement planning.

Instead of withdrawing investments early, let your SIPs continue for a longer period to enjoy significant wealth creation.

Also Read: SIP Plans for 5 Year Investment in India

Conclusion

The 7-5-3-1 Rule in SIP Mutual Fund Investment is a simple yet powerful strategy for long-term wealth creation. By following this rule, investors can:

• Stay invested for at least 7 years to potentially optimize returns.
• Diversify their portfolio across at least 5 different mutual fund categories to manage risk.
• Overcome emotional biases and stick to their investment plan.
• Ensure they increase SIP contributions every year to accelerate compounding and growth.

FAQs:

Can the 7-5-3-1 rule be customised to individual investment preferences?

Yes, the 7-5-3-1 Rule in SIP mutual fund investment can be adjusted based on an investor’s risk tolerance, financial goals, and time horizon. Some may choose to stay invested for more than 7 years, diversify across more funds, or tailor their portfolio based on personal preferences.

What are the potential benefits of following the 7-5-3-1 rule?

• Encourages long-term investing, which enhances wealth creation potential.
• Reduces risks through diversification.
• Helps investors avoid emotional investment decisions.
• Potential for maximising returns through compounding and disciplined investing.

How can investors implement the 7-5-3-1 rule effectively?

• Choose mutual funds that align with your financial goals.
• Set up a disciplined SIP plan and stick to it.
• Diversify investments across multiple fund categories.
• Avoid making impulsive decisions based on short-term market fluctuations.
• Increase SIP contribution every year.

How does diversification play a role in the 7-5-3-1 rule?

Diversification helps investors spread their risks across different mutual fund categories, which is likely to reduce the impact of poor performance in any single asset class. It ensures a balanced portfolio and optimises the overall portfolio risk/return profile by taking advantage of multiple investment opportunities.