Things you must remember before starting sip

Topics Covered

• 1. Don't spread your SIP across too many funds
• 2. To the extent possible, avoid dividend schemes in your SIP
• 3. Do not try to time the market too often with your SIP
• 4. Do not become a victim of the short-term syndrome

1. Don't spread your SIP across too many funds

This is a cardinal blunder many mutual fund investors commit. To spread their investments, they spread across too many schemes in too many different funds. This is not required. Let us look at a thumb rule. If you are looking to allocate Rs.50,000/- per month to SIP, then ensure that this is spread across at the most 2-3 funds. If you spread this money across 10 funds, it becomes a major hassle for you to track the performance of these funds. You are in equity funds because of diversification benefits. By holding too many different schemes you do not add to diversification but only complicate your investment strategy further. Keep it as simple and to a minimum number of schemes only.

Recommended Read: Expert Tips for Investing in SIP to Maximize Your Returns

2. To the extent possible, avoid dividend schemes in your SIP

Many investors fall for this simple dividend trap. Since dividends are tax-free in the hands of the investors, mutual fund investors tend to opt for dividend schemes in their SIP. This is not advisable for a couple of reasons. Firstly, when you adopt a dividend scheme, then the dividends get paid out each time the dividend is declared. While this helps you to earn tax free income, the downside risk is that you are not actually accumulating your corpus as the dividends are being taken out on a regular basis. Secondly, if your aim is to save taxes, you do not have to worry. Even if you adopt a growth scheme, you anyways plan to hold your SIP for the long term (5 years and beyond). Capital gains beyond a period of 1 year are tax-free anyways and hence there is no additional benefit in opting for a dividend scheme. To the extent possible, opt for a growth scheme as it will ensure that your corpus gets accumulated systematically over a period of time.

3. Do not try to time the market too often with your SIP

Timing the market can be quite tempting but you must desist as it defeats the basic purpose of creating equity SIP. You may have a tendency to increase your SIP amount when you feel that the market has corrected or you may try to reduce the SIP amount when you feel that markets have shot up too much in a short period of time. There is nothing wrong and you are logically on the right track. The only problem is that you are employing discretion and that is not a good idea when you are using the SIP route to long term wealth. A SIP is designed to provide stability of contribution without trying to time the market. In case you really feel that you want to get the advantage of highs and lows in the market, you can opt for a dynamic or variable SIP. Here, the fund manager will take a call to modify the SIP amount based on their researched view on the markets. That is a safer and more reliable way to get the best of market tops and bottoms. To the extent possible, do not try to time the market on your own. It is best left to the judgement of experts.

Recommended Read: Mutual Fund SIPs v/s SIP in individual stocks

4. Do not become a victim of the short-term syndrome

A lot of mutual fund investors have the tendency to compare and evaluate SIP performance over the short term. For example, SIP comparison over 3 months, 6 months, 1 year or even 2 years does not make sense. To get the real picture, you must compare an SIP for a period of 3-5 years and above. That is when you get a real picture of the fund’s performance. Over the short term, it is entirely possible that a particular fund may outperform by adding more risk to the portfolio. This will get evened out over the long term. Remember, in the short term the markets can be a slotting machine but in the long term it is always a weighing machine. When you are taking any SIP decision make it a point that you at least consider returns over a period of 3-5 years. More importantly, do not forget to consider the risk which can be measured by the Sharpe and Treynor ratios. Your SIP will be safer in the hands of a fund that is committed to getting you higher returns for every unit of risk taken. In a nutshell, an SIP is a simple, elegant and reliable method to accumulate wealth over a long period of time. An understanding of some of the basic prerequisites of an SIP will help you create long term wealth more effectively.