Mutual funds are a great way of investing in the stock markets especially for people who are new to investing. They carry relatively lower risk as compared to direct participation in the equities markets while generating comparable returns. This is because mutual funds are managed by professional managers and they often have a diversified portfolio to spread the risk around. Systematic Investment Plans or SIPs are in turn one of the most convenient ways to begin investing in mutual funds making them very popular among small and first-time investors. However, there are several mistakes that investors make which prevent them from realizing the full potential of their investments.
What is a SIP?
There are two ways to invest in mutual funds:
Lump Sum Investment
In this scheme, you invest a consolidated one-time sum into the mutual fund for a fixed period of time. Think of this as a bank fixed deposit (FD) scheme.
Systematic Investment Plan
In a SIP plan, a number of payments are made into the fund in the form of regular instalments, usually monthly, throughout the duration of the scheme. A SIP is like a bank recurring deposit (RD) scheme.
5 Common Mistakes When Investing in SIPs
Starting Too Late
Like all financial instruments, SIP investments work best when aided by the power of compounding. For compounding to work its wonders, it needs time on its side. For instance, consider the following example. Suppose you were to invest Rs. 8000 per month in SIP A for a period of 25 years and Rs. 12,000 per month in SIP B for 20 years, with each SIP giving the same compounded annual growth rate (CAGR) of 14%. At the end of their respective term period, you would have invested Rs. 24 Lakhs in SIP A and Rs. 28 Lakhs in SIP B. Which do you think would give greater returns? The answer is SIP A. At the end of each time period, SIP A would yield Rs. 2.18 crores while SIP B would yield Rs. 1.58 crores. Thus, even though you invested a smaller sum and a smaller monthly instalment, it was the greater timed period of SIP A that allowed it to generate greater returns.
Not Being Bold Enough
This might seem a little counterintuitive as most people opt for SIPs because they want to avoid the risk associated with equities, but if you want to get the most out of your SIP investment, it is advisable that you take the risk of investing in equity funds rather than just sticking to the safety of index and debt funds. Given the relatively long time frame of SIP plans, investors can afford to be a little aggressive in their strategy.
Lack of Discipline
This is one of the most common mistakes investors make when starting SIP plans. Even though they start out with great enthusiasm, within a few years they become too lax on their SIP payments and after some time, stop making the SIP payments altogether. The golden rule with SIPs is that you need to go all the way. Once you start a SIP, you must stick to it till completion to reap its full rewards. There is no in-between. If you feel paying off your SIP instalment is going to be a problem a few years down the line, you can always opt for a smaller amount.
Getting Swayed by Market Upheavals
Many people get carried away by market movements and begin to time their SIPs according to the ebb and flow of the market. Thus when the market is down they try to increase their SIP and vice-versa. SIPs are meant to relieve you of the worries of the ups and downs of the market so that you focus on other things in life. There are professional fund managers managing your SIP investment whose job is to track every move of the market so that you don’t have to. Mutual funds are long-term investment vehicles. It is important not to get carried away by market sentiments. A SIP investor should be steady with his payments regardless of the mood of the markets.
Lack of a Clear Financial Goal
This might seem like an obvious point to make but it is a very important one. Too many people start their investment journeys without any clear goal in mind. The first step to achieving a goal is to define that goal. This applies to finance just as it applies to all walks of life. Before you begin your SIP investment you need to first be clear about the purpose of the SIP. What do you intend to achieve with it? Is it for your retirement? Or is it meant to provide for your children’s education? Or are you saving up for a big foreign holiday? In each case, the amount you need and the time frame you have at your disposal to reach that amount will vary significantly thus necessitating a different approach to reach that goal.
Mutual fund SIPs are a great way for new investors to participate in the stock markets. However, it is important to avoid certain common mistakes such as keeping too short a time frame, being too conservative with investments, missing SIP payments, getting swayed by market trends, and not having a clear plan at the outset. If you stay clear of these mistakes, SIP mutual funds are a great financial tool for helping you achieve your financial goals.