A Systematic Investment Plan (SIP) in a mutual fund is a simple and effective route to wealth creation. However, some rudimentary errors can mar this process of wealth creation for an investor. The five common mistakes that may render SIP investments ineffective are:
1. Not associating an SIP with a financial goal: The first rule of investing is to have a financial goal in mind. It is thus advisable to tie SIP investments to financial goals. For instance, an investor at the beginning of their career may tie an SIP to the goal of accumulating funds for buying their dream house in a time frame of five to seven years. Similarly, an SIP may be tied to any long-term goal such as higher education of children or building a retirement corpus. The illustration shows how the earlier you start establishing your financial goals, the greater is the potential to grow your investments to achieve your future goals. It shows how an SIP of Rs.1000 invested to build a retirement corpus starts compounding at an assumed rate of return of 10% per annum.
2. Choosing an SIP based on a low NAV: The size of the NAV (Net Asset Value) tells nothing about the performance of the fund as it fluctuates on the basis of the market price of its underlying stocks. The gains and fluctuations always happen in percentages of the NAV. Typically, newly launched MF schemes would have lower NAVs as compared to older funds. It is wiser to make an investment choice based on the scheme’s performance, managers’ strategy, size of AUM and future prospects of its underlying holdings, etc.
3. Opting for an Dividend/ IDCW plan rather than a growth plan: An IDCW plan (Income Distribution cum Capital Withdrawal) of a mutual fund scheme (earlier known as the dividend plan) is one in which the investor has a pay-out from the returns of the scheme intermittently in form of income distribution. While this may seem like a good option upfront, it diminishes the effectiveness of an SIP as there is no compounding in such a plan. Not only that the dividend received is taxable but also, a growth plan of a mutual fund is where all the returns are reinvested in the fund and such returns will be compounded over the investment period. The power of compounding enhances the chance of long term wealth creation for an investor.
4. Halting an SIP in a bear market: Steep market corrections may be worrying when there is notional erosion in ones’ investments. At such times, investors tend to stop or pause their SIPs fearing further losses. This is one of the fundamental mistakes as it beats the very purpose of an SIP, which functions on the basis of rupee cost averaging. SIP is designed to purchase a greater number of units when the markets are low and a lesser number of units when markets are high. This averages out the investment cost and also enhances chances of long term risk-adjusted returns. Observe the illustration to understand how an SIP performs in a bull and bear phases. By stopping a SIP in a bear market, this mechanism is interrupted, thus beating the very purpose of an SIP. On the contrary, a bearish market condition should be used to top up SIP investment as that may help reach one’s goals faster. A step-up or top-up SIP allows you to gradually increase your SIP amount at regular or designated intervals, thereby enabling you to invest more in less time. Doing so, at regular intervals would reduce the investment cost further and help meet financial goals faster.
5. Not keeping a periodic check on SIP: Some investors believe that SIPs once begun will grow on their own and that is thus the end of the journey. In reality, however, that is where the journey of an investor begins. To ensure that financial goals are on track, it is imperative to critically assess and review the performance of your SIP at least once a year. Further, a periodic check on SIPs, will also ensure that the investment strategy is on track. Investing in SIPs has become as easy and convenient as adding items to a virtual shopping cart.
Correct selection process, continuous monitoring, periodic review of your portfolio, and avoiding the above mentioned errors will help in meeting your wealth creation goals.