The mutual fund industry has done a mighty propaganda job of ‘educating’ investors about ‘systematic investing’. So much so that many investors believe (not just new ones) that SIP is a financial instrument in of itself!
1. SIP is not different from lump sum when you invest
Every time you make a mutual fund purchase, you buy units equivalent to the value per unit of the amount you purchase. That is,
NAV on date of purchase x units allocated = purchase amount.
In a lump sum investment, you buy once. In an SIP you buy again and again.
SIP = periodic lump sum investing.
Each mutual fund unit is unique.
2. SIP is different from lump sum when you want to redeem
Many think that a sip investment is tax-free after 1 year! If the fund was an equity fund, the first SIP instalment alone will be tax-free after 1 year (as per current rules). The second instalment will be tax-free one month later and so on.
Starting an SIP in an arbitrage fund for recurring goals may not be a terrible idea (not a recommendation), but don’t assume after one year all the gains are tax-free! Especially if you are in 10% tax slab!
Exit load of the scheme will also apply to each unit individually.
3. A 3-year ELSS SIP cannot be redeemed after 3 years!
If you would like to start an SIP in an ELSS fund from April, remember that each instalment will be locked in for 3 years.
4. Mutual funds are not insurance policies
Thanks to the propaganda, we have people stating, “I would like to start an SIP for next 25 years. Please suggest some funds”.
This is not an insurance policy where you pay premiums for a set number of years, at the end of which there is a maturity value. If you blindly keep investing in the same fund, returns could well be sub-optimal, if not abysmal. Read more: Analysis: 10-year Lump sum vs 10-year SIP returns and How to Review Your Mutual Fund SIPs.
So after starting an SIP, it is important to know when to stop it!
5. Mutual funds are not money back policies!
When you make a mutual investment, you buy units as shown above. When you want to exit the investment, you are selling the units you hold at the current NAV of the fund.
current NAV x units = value you get.
This value may or many not be higher than the total amount that you have invested! There is no concept of ‘getting your money’ back with mutual funds. Or in other words, returns are not guaranteed!
6. Returns are not guaranteed!
Many investors tend to have an ‘it can’t happen to me’ tendency when the volatile nature of equity markets are pointed out – ‘but my goals are decades away!’ They argue. Well, time flies! Warning! A long-term financial goal will soon become a short-term financial goal!
We all hope that the Indian economy will grow and we can participate and profit from it, but as Mr. R Balakrishnan said, “equity will give you returns, but not when you need it!”! Active risk management is essential for equity investing.
Equity investing is not a feel-good movie where there is a climax and everything turns out okay in the end.
7. SIPs do not minimise risk!
I have said this before, but it is necessary to repeat. SIPs only average the entry point of the next installment – sometimes at lower NAV or sometimes at higher NAV. The total amount invested is subjected to the full volatility of the market. Here are a few examples.
8. Do not SIP till the ‘end’!
If your goal is say, 15 years away, do not continue your SIPs for 15 years! That can be disastrous. I would recommend having an asset allocation plan for the next 15 years in mind and gradually taper equity allocation. For example, those who have started invested in equity early in life, say about 60-70% can gradually taper it down to 30-40% in the last decade before retirement. For other goals, this has to be tapered to 0%. However, doing this will affect the investment amount. So you can use this tool to have an asset allocation plan and taper Financial Goal Planner with Flexible Asset Allocation
Have an exit strategy in place!
9. Start an SIP only if you must! It is not necessary to do so!
The propaganda bandwagon (fuelled from the expense ratio of existing mutual fund investors in the name of ‘investor awareness expenses’) has made investor believe that filling a form and setting up a ECS mandate with a bank makes investors disciplined. It is a fancy way of saying, I need regular income from the investors investment. Stop for a moment and think why AMCs make it difficult to stop a SIP!
In this day and age, there is absolutely no need to start a SIP! It takes about 45 seconds for a person llow-tech person like me to make a mutual fund investment each month. Manual monthly investing takes discipline. Timing the market takes greater discipline. An automated SIP investment has nothing to do with discipline!
If you do want to start an SIP, set it up only for about 3 years. Review its performance and either restart in the same fund (the AMC will nag you with reminders) or in another fund ruthlessly.
10. Same applies to an STP!
There is no need to start an STP from a debt fund to equity to gradually invest a lump sum. The AMC wants to lock-in on your lump sum in a debt fund. Manual purchases 2/3 times from an SB account to the fund you want is all that is required. Read more: How to invest a lump sum in an equity mutual fund?
11. Learn about portfolio rebalancing