5 common mistakes that prevent investors from making the most of SIPs

Investors should avoid factoring in funds’ NAV when contemplating investments in mutual funds through SIP.

Systematic Investment Plans (SIPs) have been gaining significant acceptance among retail investors for achieving crucial financial goals by investing regularly in a disciplined manner. SIP helps investors derive the benefits of rupee cost averaging approach and the power of compounding. However, lack of product knowledge can push many SIP investors, especially new investors, towards committing investment mistakes.

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Here are 5 such common mistakes that can adversely impact the wealth creation objectives of SIP investors:

1. Considering funds with lower NAVs as cheaper

Many retail investors consider funds having lower NAVs to be cheaper and thus, invest in them through SIPs in the hope of generating higher returns. However, a fund’s NAV can be high or low because of multiple reasons. For instance, as a fund’s NAV depends on market price of its underlying assets, a well-managed scheme’s NAV would grow better as compared to other funds. Likewise, newer funds would have lower NAVs than older funds as the former got shorter time to grow.

Thus, investors should avoid factoring in funds’ NAV when contemplating investments in mutual funds through SIP. They should instead account for the funds’ past performance and its future prospect of performing better than benchmark indices and peer funds as a selection parameter.

2. Opting for dividend option instead of growth plan

Many investors choose the dividend plan over growth plan as they consider dividends declared by mutual funds to be a windfall income. However, what such investors are unaware of is that the dividends are paid by the fund from their own AUM. As an outcome, NAV of dividend declaring mutual fund is deducted by the value of dividend paid out on the dividend record date.

Furthermore, the dividend amount is calculated on funds’ face value and not on the basis of NAVs. For example, suppose a fund with NAV of Rs 100 declares a dividend of 30%. The dividend received by the fund’s investors would be Rs 3 i.e. 30% of the fund’s face value, which is Rs 10. NAV of the fund will also fall to Rs 97 after the dividend record date. Moreover, opting for the dividend has also become less tax-efficient as mutual dividend receipts are taxed as per the tax slab of the investor.

Hence, investors opting for the SIP route should opt for the growth option to make the most from the power of compounding.

3. Stopping SIPs during bearish market condition

Steep market corrections or bearish market situations often lead many investors to stop their SIPs owing to the fear of incurring further losses. However, doing so negates one of the major benefits of using SIP to invest in equity mutual funds i.e. rupee cost averaging, by purchasing more units at lower NAVs during market corrections and dips. As quality equities are available at attractive valuations during the period of steep market corrections or bearish market conditions, continuing with the SIPs during such periods would reduce your investment cost and earn higher returns over the long term.

In fact, SIP investors with large investible surpluses can further exploit such market situations by topping up their SIPs with lump sum investments in a staggered way basis their asset allocation strategy. Doing so would further reduce the investment cost and also assist them to attain crucial financial goals sooner.

4. Expecting unrealistic returns

Exceptional returns generated during bull markets lead a large number of fresh retail investors to begin their equity fund journey through SIPs. Many also end up investing in equity funds through SIPs for their short term financial goals in the hope of generating exceptional returns. However, returns generated in the course of a bull market phase cannot sustain over the long run; and every bull market is accompanied by a bearish market or correction phase. If the equity market witnesses a bearish market or correction phase, such investors may have to redeem their investments at a loss in order to meet their short-term financial goals.

Instead, equity fund investors opting for the SIP route should remain invested in equity funds at least for 5 years, preferably 7 years to derive maximum benefit from the economic cycle. Those seeking to meet short-term financial goals through SIPs should invest in debt funds as these offer higher capital protection and income certainty than equity funds.

5. Factoring recent performance during fund selection

Many SIP investors make the fund selection decision on the basis of recent performances of the fund, especially the returns generated during the last 1 year. However, such outperformances or even under-performances can be temporary or short term in nature. Even good funds with excellent track records in the past can underperform its peer funds and benchmark indices in the short-term due to the fund management style and prevailing market conditions.

Thus, investors should select mutual fund for SIPs after comparing its past performances with benchmark indices and peer funds for the last 5-year and preferably 10-year period. Comparing the performance over the last 10-year period will give them a better idea about how the funds have performed over an entire economic cycle.

(The author is Senior Director, Paisabazaar.com)