Systematic Investment Plans (SIPs) provide a host of benefits to mutual fund investors. They make for a much needed disciplined approach to investing by setting aside a pre-determined amount towards investment in chosen funds. They offer the benefit of rupee cost averaging because of the aforementioned investment discipline, which results into a substantial investment as an investor heads towards the end of his investment cycle.
Then there is the benefit of compounding where the impact of disciplined investing via SIPs can be seen the most over the long term. SIPs also provide convenience and flexibility in managing one’s investments.
Though the mechanism may seem quite fruitful, it does have pitfalls if not used correctly. Let’s look at 3 mistakes that investors may commit while making SIP investments which need to be avoided to let it work efficiently.
- Investing impractical amounts:
An SIP requires the investor to choose a set amount which is deducted from a specified bank account and deposited into the chosen mutual fund on a preset date. In choosing the amount, investors can make one of two mistakes:
- Setting the amount too low:
This is a common mistake committed especially by new investors. They choose too small an amount to invest monthly in their desired fund because they want to take small steps towards investing and see whether mutual fund investing is rewarding or not. But by doing so, they are increasing chances of deflating the overall wealth that they could have created over a period of time. Low inputs can only lead to low outputs regardless of the returns of the fund. By doing so, the investor in either going to get demotivated to invest more, or be left with much lower wealth than he could have otherwise generated.
- Setting the amount too high:
Aggressive investors, especially those who have tasted some success with mutual fund investing, may opt for very high SIP amounts. But this is a mistake as well because what is essential for SIPs is consistency in investment. High amounts are certainly welcome, but they will be of little use if the size of investment cannot be invested consistently. If after an initial large amount, an investor needs to pull down the size of the EMI due to some unforeseen circumstance, then the mechanism will not yield desired results.
- Test and flee:
Investors who opt for an SIP of 12 or 24 months may decide to use the period to determine if they want to continue using the mechanism further. However, by its design, SIP tends to deliver returns only in the long run. Expecting good returns in 1 or 2 years from a fund may be expecting too much, if the market sentiment remains neutral or bearish in this period.
A majority of those investors who experience such a market phase may decide to discontinue SIPs or may step away from mutual funds altogether. By doing so, they may be making the biggest investment mistake of their lives.
A short duration robs an investor the benefit of compounding as this is too short a period to make the right assessment about one’s investment. It is possible that he may be invested in the wrong fund, but he may end up blaming SIPs for the poor performance of his portfolio. Also, shorter tenures mean that rupee cost averaging does not play out in its fullest.
- Investing in the wrong fund:
A fund is right or wrong based on an investor’s objective, life stage, and capability of handling risk. Due to this, investors with similar incomes may need to choose different funds. However, they may not carry out a full investment profile assessment, which may result into them choosing funds unsuitable to them.
Since they would have chosen SIPs to invest in those funds, they would blame high volatility or underperformance of a fund on the mechanism, though the truth is far from that. Reassessing their portfolio choice there is more important than abruptly stopping an SIP as it is just a mechanism and does not determine portfolio performance by itself. You can check out the best explanation on SIP Investment by OroWealth to know more about SIPs.