Why SIPs are brain-friendly

Emotions are good for your overall well-being, but those can sometimes get in the way of your financial decision making.

For instance, the possibility of a negative future outcome from an investment could prompt you to not take a decision today even though that investment may be required to achieve your life goal. It is, therefore, important that you distance yourself from your investment decisions.

Here, we discuss how systematic investment plans (SIPs) help moderate emotions and improve your chances of achieving life goals. The possibility of regret in the future because of a bad outcome prompts many to postpone taking a decision today. Suppose you want to accumulate money to make down payment for a house 7 years hence. You know that investing in bank deposits is not enough; lower post-tax returns would mean you have to save more to achieve your goal. But investing in equity could lead to losses.

That is why SIPs are helpful.

First, SIPs eliminate the need for you to take a decision every month. The more active decisions you take, the more regret you could experience! An SIP is set up as an automatic debit from your designated bank account into your preferred investment.

Such active distancing from an investment decision reduces regret. It also offers a disciplined approach to saving. How? Analytical thinking as opposed to intuitive thinking consumes energy and can be tiring. That is why our brain typically applies mental shortcuts (heuristics in behavioural psychology) to take decisions. You order food from a restaurant that has good reviews. You do not ‘analyse’ this restaurant before placing the order. Investment decisions are different. A wrong decision could reduce your chances of achieving a life goal. So, you cannot risk applying heuristics to choose investment products. But applying analytical thinking each time you make a decision can be overwhelming and stressful. We, therefore, often tend to avoid taking such decisions.

By setting up an SIP, you eliminate the need to apply analytical thinking each month you make the investment.

Active distancing

Active distancing works well if the entire process is mechanical. First, set up a savings account in a bank other than the one where your monthly income is credited. We call this the master investment account. This savings account is the one designated for all our equity SIPs. It can also be used to set up a recurring deposit with the same bank. Second, every month, transfer your monthly savings from your salary account to this master investment account. This should be set up to happen on the day your salary is credited. Third, your equity SIP should be preferably invested equally over two dates every month if you are allocating 50% or more of your monthly savings to equity.

Note that redemptions and dividends from your investments will be credited into this master account, making it easy for you to use the money only for the intended purpose. We cannot set aside emotions when we take decisions. But we can set up a process that can help us moderate the negative effects of emotions when we take financial decisions. SIPs for all your life goals are the best way to temper inertia and regret. Note that an SIP can be set up for all your investments — equity, bonds and even real estate (EMIs). The active decision you have to make is when you set up the SIP — how much to invest, which product to choose and the days of the month the investment should be made. Thereafter, you have to engage your analytical brain only for redemption requests.

(The writer offers training programmes for individuals to manage their personal investments)

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Printable version | Mar 2, 2021 2:18:36 AM |

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