Systematic Investment Plans (SIPs) have increasingly become popular among retail investors as a means to achieve essential financial objectives through regular and disciplined investing. SIPs enable investors to benefit from the principles of rupee cost averaging and the advantages of compounding.
Still, a lack of understanding regarding investment products can lead many SIP investors, particularly those who are new to the market, to make significant investment errors. Here are five common mistakes that can negatively affect the wealth accumulation goals of SIP investors:
1. Choosing Dividend Option Over Growth Plan
Numerous investors prefer the dividend option rather than the growth plan, perceiving the dividends issued by mutual funds as unexpected income. However, these investors may not realize that the dividends are disbursed from the fund’s own assets under management (AUM). Consequently, the NAV of a mutual fund that declares dividends is reduced by the amount of the dividend distributed on the record date.
Additionally, the dividend is determined based on the fund’s face value rather than its NAV. For instance, if a fund with an NAV of Rs 100 announces a dividend of 30%, the amount received by investors would be Rs 3, which represents 30% of the fund’s face value of Rs 10. Following the dividend record date, the NAV of the fund would decrease to Rs 97. Furthermore, selecting the dividend option has become less tax-efficient, as mutual fund dividend receipts are taxed according to the investor’s applicable tax bracket. Therefore, investors utilizing the SIP approach should consider the growth option to make the most of compounding.
Also Read: Retirement Planning: Are pension funds a smart choice for steady income?
2. Assuming funds with lower NAVs to be more affordable
Many retail investors mistakenly perceive funds with lower Net Asset Values (NAVs) as being less expensive, prompting them to invest in these funds via SIPs with the expectation of higher returns. However, a fund’s NAV can vary for several reasons. For example, since a fund’s NAV is influenced by the market value of its underlying assets, a well-managed fund is likely to experience better growth in NAV compared to others.
Additionally, newer funds typically have lower NAVs than their older counterparts due to having less time to appreciate in value. Therefore, investors should refrain from using NAV as a criterion when considering mutual fund investments through SIPs.
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