Systematic Investment Plans (SIPs) are a way of investing, generally offered by mutual funds to help investors invest in a disciplined form. It allows investors to invest a fixed amount of money at regular intervals to generate a big corpus in the longer term.
SIPs have been one of the most preferred investment options for mutual funds. Young and old, new and experienced, it has been gaining acceptance among all types of investors. This is not only because it's easier on the pockets but also because it generates massive interest by the power of compounding.
However, many times investors commit some very common mistakes while investing in a SIP which can cost them in the long run.
Let's take a look at some of these.
1) One of the biggest mistakes investors make is considering that MFs with low net asset value (NAVs) are cheaper and can generate higher returns. It is more important for investors to look at the past performance of a mutual fund. NAV of a mutual fund can be low for negative reasons as well and does not determine its future potential.
Even though past performance does not guarantee the future, it is a better comparative tool and selection criteria for mutual funds than NAVs.
2) The next very common mistake made by investors is topping or skipping SIP payments during a bear market. It has been thoroughly criticised by experts. In a bear market, or during a market crash, the NAVs of your mutual fund decline, allowing you to buy more units of the fund than during a bull market. Like, how investors use the buy on dips strategy in stock markets. So when the market recovers, you will get more return since the number of units owned is higher. Instead of redeeming or stopping SIP during that period, it would be better to invest more and accumulate extra units of your chosen mutual fund, since they will be available at a cheaper rate. Continuing your investment during this period will decrease your investment cost and increase your returns in the future.
3) Another mistake people make is opting for the dividend plan rather than the growth plan. Unless you absolutely need a regular income, the dividend option is never the better path. It not only decreases the NAV of your units but in the long run gives lower returns than the growth option. Suppose the NAV of your fund is ₹100 and you get a dividend of ₹3. Then the NAV will fall to ₹97 from ₹100. The dividend option is also less tax effective as the dividends are taxed. In the growth option, since the profits are reinvested, it makes the most of the power of compounding and maximises your returns. Also, you are only liable to pay STCG or LTCG depending on the amount of time you hold your fund and no dividend tax.
4) Starting SIP for the short term is also one of the most common mistakes made by investors. SIPs tend to do better with a long-term view, also long-term SIPs have more tax benefits. LTCG is lower than STCG and is taxed only at returns of over ₹1 lakh. In the shorter term, the power of compounding also diminished and hence the returns are lower.
5) Not increasing your SIP amount over the years is another oversight by investors. Suppose you invest ₹3000 in 2010, which is 10 percent of your salary, investing the same amount in 2021 does not make sense. You should keep increasing your SIP amount as your salary increases to maximise your returns. Also, you have to take into account inflation. The value of ₹3000 in 2020 is way less than what it was in 2010, so unless you keep increasing the amount at least in line with the inflation, the real return on your SIP will also decrease.
These are some key mistakes that investors make during a SIP. However, it is important that investors do not have unrealistic goals from their SIP investments and continue to rebalance and review their portfolios in line with market trends to get the most out of the investments.