How to avoid the 6 cardinal sins of SIP investing

Here are 6 cardinal sins that SIP investors must diligently avoid.

Aug 30, 2021 07:08 IST India Infoline News Service

The big story in mutual fund investing has been the growth of SIPs or systematic investment plans. Even the mega NFO in recent months like SBI Balanced Advantage Fund and ICICI Prudential Flexi Cap Fund resulted in a sharp spike in SIP accounts.
Data Source: AMFI

The monthly SIP flows into mutual funds have moved into a higher plane in the current financial year. At higher levels, investors in equity funds are taking solace in the SIP, in the hope that they would eventually end up with a lower cost of holding. But the bigger story is elsewhere. For example, the total number of SIP folios have touched a record level of 4.17cr and SIP AUM now accounts for over 40% of the overall equity fund AUM.

This frenetic growth brings us to a fundamental question. Are investors doing SIPs right? Even as SIP looks like a very simple product, there are certain nuances.

Here are 6 cardinal sins that SIP investors must diligently avoid.

1. Focusing on returns over consistency

A SIP that gave 16% returns in the last one year is surely more attractive than a SIP that returned just 12.5%. It looks optically attractive, and adds to your wealth. But the question here is whether these returns have come at the cost of consistency. The below illustration of 2 funds with starting NAV of Rs100 answers the question.
Name of Fund End of Year 1 NAV End of Year 2 NAV End of Year 3 NAV
Fund Alpha Rs114 Rs130 Rs145
Fund Beta Rs98 Rs109 Rs145

Both the funds have given CAGR returns of 13.2% over 3 years. Can you pick either of them? Fund Alpha is more consistent as its returns in each year have been close to the CAGR. But Fund Beta has been erratic with negative returns in first year, normal returns in the second and supernormal returns in third year. You can be indifferent to when you enter Fund Alpha but that is not the case with Fund Beta. If you want to avoid the risk of timing, focus SIPs on funds that give consistent returns.

2. Getting caught in the low NAV syndrome

Does low NAV mean the fund is under-priced? That is like asking whether penny stocks are more attractive than A-group stocks. NAV has nothing to do with the fund being attractive or otherwise. If you buy an equity fund when the index is 20% lower, then you should make good returns irrespective of whether the fund NAV is Rs11 or Rs110. In fact, funds with low NAV could be either badly managed or taking on too much risk. It is always better to not to judge a fund by its NAV.

3. Evaluating a fund based on 1 year returns

Let me add a caveat here. Don’t ignore 1-year returns, but take an initial decision based on 5-year CAGR returns. Then you can monitor the consistency of the fund based on 1-year returns. Normally, the argument is that a fund manager who can manage a year well can also manage 5 years. You can look at yearly rolling returns each month to judge for consistency. It is good to look at 1-year returns but let your essential SIP decision be based on long-term consistent returns.

4. Opting for a dividend plan to get regular income

There are 2 arguments against a dividend plan. Firstly, dividend plans don’t compound returns and defeat the basic purpose of wealth creation. Secondly, dividend plans are tax-inefficient. Dividends are currently taxed at your incremental income tax rate. On the other hand, long term gains are taxed at just 10% above Rs100,000 per year while short term gains are also taxed at a concessional rate of 15%. You can further reduce your taxes by setting off losses of previous 8 years. In case you want regular income, opt for a systematic withdrawal plan (SWP) in a growth scheme.

5. Stopping the SIP because markets have crashed

That is a common mistake. SIPs are based on the rupee-cost averaging. When markets are down, you get more units so that is your golden opportunity to reduce cost of holdings. In fact, the best returns on SIPs are realized when you persist with the SIP through bear markets and then reap the benefits when the markets bounce back. That calls for patience.

6. Deciding your SIP amount based on available surplus

This is a financial planning issue, but something you must be aware of. What should be your monthly SIP size? Start with your long-term goals and work backward. Then see how much savings you can squeeze out of your income and work towards such SIP targets. If you wait till you have enough surplus to start your SIP, it is never going to happen.

There is no rocket science about SIPs. They are boring but reliable method of creating wealth. More importantly, avoid these six cardinal sins of SIP investing.

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