SIP Investment: 5 common mistakes to avoid to make the most of SIPs

Systematic Investment Plans (SIPs) have increasingly become popular among retail investors as a means to achieve essential financial objectives through regular and disciplined investing. SIPs enable investors to benefit from the principles of rupee cost averaging and the advantages of compounding.

Still, a lack of understanding regarding investment products can lead many SIP investors, particularly those who are new to the market, to make significant investment errors. Here are five common mistakes that can negatively affect the wealth accumulation goals of SIP investors:

1. Choosing Dividend Option Over Growth Plan

Numerous investors prefer the dividend option rather than the growth plan, perceiving the dividends issued by mutual funds as unexpected income. However, these investors may not realize that the dividends are disbursed from the fund’s own assets under management (AUM). Consequently, the NAV of a mutual fund that declares dividends is reduced by the amount of the dividend distributed on the record date.

Additionally, the dividend is determined based on the fund’s face value rather than its NAV. For instance, if a fund with an NAV of Rs 100 announces a dividend of 30%, the amount received by investors would be Rs 3, which represents 30% of the fund’s face value of Rs 10. Following the dividend record date, the NAV of the fund would decrease to Rs 97. Furthermore, selecting the dividend option has become less tax-efficient, as mutual fund dividend receipts are taxed according to the investor’s applicable tax bracket. Therefore, investors utilizing the SIP approach should consider the growth option to make the most of compounding.

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2. Assuming funds with lower NAVs to be more affordable

Many retail investors mistakenly perceive funds with lower Net Asset Values (NAVs) as being less expensive, prompting them to invest in these funds via SIPs with the expectation of higher returns. However, a fund’s NAV can vary for several reasons. For example, since a fund’s NAV is influenced by the market value of its underlying assets, a well-managed fund is likely to experience better growth in NAV compared to others.

Additionally, newer funds typically have lower NAVs than their older counterparts due to having less time to appreciate in value. Therefore, investors should refrain from using NAV as a criterion when considering mutual fund investments through SIPs. Instead, they should focus on the fund’s historical performance and its potential to outperform benchmark indices and comparable funds as key factors in their selection process.

3. Anticipating Unrealistic Returns

The remarkable returns experienced during bull markets often entice numerous new retail investors to embark on their equity fund journey through SIPs. Many individuals also invest in equity funds via SIPs with the intention of achieving short-term financial objectives, driven by the expectation of extraordinary returns. However, the returns realized during a bull market are not sustainable in the long term, as each bull market is typically followed by a bearish market or a correction phase. Should the equity market enter a bearish phase or experience a correction, these investors may find themselves compelled to liquidate their investments at a loss to fulfill their short-term financial needs.

Consequently, equity fund investors utilizing the SIP approach should aim to maintain their investments for a minimum of five years, ideally seven years, to fully capitalize on the economic cycle. For those with short-term financial goals, it is advisable to consider debt funds, which provide greater capital protection and income stability compared to equity funds.

4. Halting SIPs During Bearish Market Conditions

Significant market downturns or bearish trends often prompt many investors to halt their SIPs due to concerns about potential losses. However, this action undermines one of the primary advantages of SIPs in equity mutual funds, which is rupee cost averaging, as it allows investors to acquire more units at lower NAVs during market declines. During periods of substantial market corrections, quality equities are often available at appealing valuations, and maintaining SIPs during these times can lower investment costs and yield greater returns in the long run. Moreover, SIP investors with substantial investable funds can take advantage of such market conditions by incrementally increasing their SIP contributions through lump sum investments, aligned with their asset allocation strategy. This approach not only reduces the overall investment cost but also aids in achieving important financial objectives more swiftly.

5. Considering Recent Performance in Fund Selection

A significant number of SIP investors base their fund selection on the recent performance of the fund, particularly the returns achieved over the past year. However, such short-term outperformance or underperformance may be temporary. Even well-established funds with strong historical performance can lag behind their peers and benchmark indices in the short term due to variations in fund management strategies and current market conditions.

Therefore, investors should evaluate mutual funds for SIPs by comparing their historical performance against benchmark indices and peer funds over a span of five to ten years. Analyzing performance over a decade provides a more comprehensive understanding of how the funds have fared throughout an entire economic cycle.