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The number of people investing through Systematic Investment Plan (SIP) across the country has reached a record level. Every month a fixed amount is deducted from the bank account, but when investors check their portfolio after three-four years, they often feel disappointed. Many times the returns look slightly better than bank FD or appear completely flat. In such a situation, investors feel that there is more risk and less profit in mutual funds. The reality is that the problem lies not in the SIP model, but in the way it is implemented and the common mistakes.
Most of the new investors start SIP in any fund after seeing the returns of the last one year. When a sector like IT, Pharma or Defense is on a boom, people start investing money in sector or thematic funds. As soon as the cycle in that sector changes, the performance of the fund falls and the portfolio goes into the red. For long term mutual funds, flexi-cap, large and mid-cap or index funds should be the main base and not any trending sector.
A common mistake that investors make is that they start SIP of Rs 500 or Rs 1000 in 10 to 15 different schemes. They feel that keeping more funds will reduce the risk. Actually this is called ‘portfolio overlap’. If you have large-cap or flexi-cap funds of five different companies, they all will have the same stocks like Reliance, HDFC Bank or Infosys. This neither reduces the risk nor increases the return, but increases the expense ratio. 4 to 5 good funds are sufficient for a balanced portfolio.
Earnings and inflation increase every year, but investors keep their SIP amount the same year after year. If you started with Rs 5,000 a month five years ago and are losing the same amount even today, inflation eats up a major portion of your returns. It is important to add a step-up SIP of at least 10% every year with the increase in salary or income. This small change can almost double your final corpus in 10 to 15 years.
The very nature of the stock market is full of ups and downs. When there is a correction of 10% or 15% in the market, many investors get nervous and pause or redeem their SIPs. This is completely against the basic principle of SIP ‘Rupee Cost Averaging’. During recession or downturn, when NAV is cheaper, you get more units for your fixed amount. When the market recovers, these cheaper units create wealth faster. Stopping SIP during downturn proves to be the biggest harmful decision.
Many investors do not know whether they are investing in regular plan or direct plan. Regular plans include distributor or broker commission, due to which their Total Expense Ratio (TER) is 0.5% to 1.5% higher than the Direct plan. This may sound like a small percentage, but in a compounding journey of 15 to 20 years, this commission deducts 15% to 20% of your total corpus. Switching your portfolio to a direct plan is an easy way to increase net returns.
Many investors opt for ‘Payout of Income Distribution cum Capital Withdrawal’ (IDCW) in the greed for regular income. When the fund house pays dividends, it is deducted from the NAV and is also taxed as per the tax slab of the investor. This breaks the chain of compounding. If your goal is to create a large fund for retirement, home or child’s education, then you should always choose the ‘Growth’ option so that every rupee can be reinvested and get the full benefit of compounding.
The formula of ‘invest and forget’ is not entirely correct. It is important to review your portfolio at least once a year. If a fund is lagging its benchmark index and peer funds for two to three years continuously, changes in its fund manager or strategy should be examined. Also, the equity and debt ratio should be rebalanced as you approach your target so that your accumulated profits are protected from sudden market falls.
If your portfolio is not growing as expected, then first make a list of your funds. Eliminate duplicate or same-category funds and narrow them down to 3 to 4 strongly diversified funds. Convert your plans to Direct Growth and turn on the automatic 10% annual step-up. Instead of reacting to every small and big movement in the market, keep a vision of at least 7 to 10 years. When discipline and the right strategy come together, the true power of SIP comes to the fore.