5 common SIP mistakes when choosing a Mutual Fund.
These 5 common SIP mistakes diminish your returns. SIPs are considered to be the 8th wonder of the world as it involves compounding. However, everyone creates common SIP mistakes when investing. Investing regularly and discipline is a key component of Systematic Investment Plans (SIPs) that have gained a significant amount of popularity among retail investors in order to accomplish key financial goals. The rupee cost averaging method is the key to reaping the benefits of compounding. SIP investors, especially new ones, may, however, opt to commit investment mistakes due to a lack of product knowledge.
In this article, we will showcase 5 common SIP mistakes that investors can make that may adversely affect their wealth creation goals. These common SIP mistakes lead to choosing a worse Mutual Fund.
Lower NAVs funds are not cheaper!
This is the first and most repetitive out of the 5 common SIP mistakes. In order to generate higher returns, many retail investors invest in funds having a lower NAV through SIPs, believing that they offer lower costs. Despite this, there are a number of reasons for a fund’s NAV to vary. The price of a fund’s underlying assets determines its NAV, so a fund with well-managed assets would have a higher NAV than unmanaged funds. A relatively new fund will have a lower NAV than a more established one since the latter got less time to develop.
When investing in mutual funds through SIP, investors should avoid factoring in funds’ NAVs. In place of benchmark indices and peer funds, they should instead judge the funds based on their past performance and their potential to behave better in the future.
Always Choose Growth Plan over Dividend Plan
Having dividends declared by mutual funds as a windfall income is a major reason why investors choose the dividend plan over growth plans. They don’t know, however, that the fund pays dividends from their own assets under management. By dividing the NAV of the dividend declaring mutual fund by its dividend payout on the dividend record date, the NAV of the dividend declaring mutual fund is reduced.
Further, dividends are calculated on the basis of face value rather than NAV. As a hypothetical example, consider a fund with a NAV of Rs 100 declaring a 30% dividend. The fund’s shareholders will receive a dividend of Rs 3, which is 30% of the fund’s face value, that is, Rs 10, which is Rs 3 for the fund’s investors. A dividend record date will also result in a drop in the NAV of the fund to Rs 97. Moreover, dividends have become less tax-effective because the tax rate on mutual dividends varies according to the investor’s tax bracket.
Therefore, investors seeking to benefit from compounding should choose the growth option when choosing the SIP route.
Do not stop SIPs when the market tumbles
Due to the fear of incurring further losses, many investors stop their SIPs during steep market corrections or bearish market conditions. This negates one of the main advantages of using SIPs in equity mutual funds, namely rupee cost averaging, by investing in more units at a lower NAV during corrections and dips in the market. When the market is in a period of steep correction and/or bearish conditions, quality stocks can be found at attractive valuations, so you would be able to reduce your investment cost and earn higher returns.
If you have a large investible surplus, you may be able to take advantage of the market’s conditions by adding lump sum investments to your SIP in a staggered way according to your asset allocation strategy. Additionally, this would enable them to achieve crucial financial goals earlier and further reduce the investment costs.
Do not expect unrealistically possible returns
SIPs have become a popular way for retail investors to invest in equity securities since bull markets generate exceptional returns. In order to meet their short-term financial goals, many people invest in equity funds through SIPs in the hope that they will generate outstanding returns. Bearish market phases are often accompanied by bull market phases; however, returns generated during bull market phases cannot be sustained over time. Such investors may feel compelled to redeem their investments at a loss if the equity market experiences a bear market or correction phase.
In order to maximize their economic benefits while investing in equity funds through SIP, equity fund investors should stay in equity funds for at least five years, preferably seven years. Investment in debt funds offers higher capital protection and income certainty than equity funds for those seeking short-term financial goal attainment through SIPs.
Do not consider only the recent performance of a Mutual Fund
These are the last 5 common SIP mistakes. An investor often chooses a fund based on its recent performance, specifically the returns generated during the past year. Nevertheless, such outperformance or even underperformances may only be temporary. Due to the fund management style and current market conditions, even good funds previously with excellent track records can underperform peers and benchmarks in the short term.
Thus, investors should compare SIP mutual fund returns with benchmark indexes and peer funds for the past five and preferably 10 years before selecting the fund for SIP. The performance of the funds over an entire economic cycle can be traced using the 10-year performance comparison.
Thus, these were the 5 common SIP mistakes to avoid when choosing a Mutual Fund. Once you follow this, you would be on the path to creating a stable long-term wealth for yourself. Don’t forget to share these 5 tips with your contacts as well! Drop us if you have any tips other than these 5 common SIP mistakes.