Investing regularly seems simple, but in reality, many investors face dilemmas. How long should I hold my investments? How do I spread my capital across different funds? And above all, how can one avoid feeling anxious when the stock market declines?
As these questions are raised so often, financial planners have summarised the answers in one easy-to-remember framework – the 7-5-3-1 rule. Although it is not a strict formula, it serves as a useful guide for SIP investors to build wealth steadily, unaffected by short-term stock market volatility. Here, in this blog, we will understand what the 7-5-3-1 rule means and how to apply it.
What is the 7-5-3-1 rule?
The 7-5-3-1 rule provides a simple framework for creating a disciplined SIP investment. It is based on 4 core principles: investing for 7 years and more, diversifying investments across 5 fund categories including index funds where appropriate, preparing for 3 emotional phases during market cycles, and increasing SIP contributions annually.
The objective behind creating such an investment strategy is to enable investors to focus on building long-term wealth rather than reacting to short-term market changes.
Here is a breakdown of 7-5-3-1 rule and its key components:
7 – Stay invested for at least seven years
The 7 represents the significance of time. Equity mutual funds are subject to market volatility, which means that investors should not evaluate their investment on the basis of a few months or one year. Investing for a longer duration allows the portfolio to navigate multiple market cycles and benefit from the power of compounding.
However, seven years is a general rule of thumb; it does not guarantee any returns.
5 – Diversify your investments
The 5 represents the five fingers of a hand, which shows diversification. This means avoid investing all your capital in one asset or investment category. However, diversifying investments doesn’t mean buying five different mutual funds. Instead, create a diversified portfolio by choosing funds with varied goals and avoid unnecessary duplications in your investments.
3 – Prepare for emotional stages
Ask yourself three questions before starting an SIP: What are my financial goals? When will I need the funds? And lastly, how much risk can I tolerate? These questions will guide you in deciding the appropriate mutual fund category as well as investment strategy that fits it. They help you prepare for 3 emotional phases during market cycles
1 – Increase investment every year
Increase your investment every year. It is simple but helps with compounding.
How to apply the 7-5-3-1 rule in mutual fund selection
Follow these steps to apply the rule to SIP investment strategy.
- Start with the goal: Be clear about what you want to achieve and when you need funds. Knowing this will help you decide the type of mutual fund to invest in.
- Give it time: If your objective is a long-term investment, then invest in options that allow you to keep your investments locked in for several years. Do not opt for equities for short-term goals.
- Build a balanced portfolio: Create a diversified portfolio to reduce dependence on any one fund or asset class. Choose complementary funds rather than investing in several similar schemes.
- Check three things: Before investing, you need to know your goals, investment duration and capacity to bear market fluctuations.
- Maintain consistency: Invest systematically through various market cycles and refrain from repeatedly switching funds based on short-term gains.
Conclusion
The 7-5-3-1 rule highlights four valuable aspects of SIP investments, including adopting a long term perspective, creating diversified investments, managing emotions and reviewing SIP contributions annually.
The rule is effective because it promotes discipline rather than strictly following the numbers. The investment duration, portfolio and SIP contributions must be aligned with an investor’s financial goals, capacity to bear risk, investment time frame and current financial condition.
