Two Misbeliefs about Mutual Funds and SIPs

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  • Mr Market
  • 2-Nov-2019

When we keep hearing about something very often without spending time in really understanding the same well enough, we tend to make opinions based on our vague notions and collected prejudices about that matter. One such popular topic is that of the Equity Mutual Funds and SIPs. We see a lot of people having misbeliefs about equity mutual funds and the term famously called SIPs. These, often negative but ultimately incorrect, myths can have a dramatic toll on your financial planning over a long period of time. We explain you the same in simple form and hope to clear the confusion within the mind of an existing as well as a potential investor.


Let’s first understand what a Mutual Fund is. Simplistically, a mutual fund is a pool of money managed by a professional Fund Manager. From an operational standpoint, it is a trust that collects money from a number of investors and invests the same in either of or a combination of equities, bonds, money market instruments and some other securities. As a corollary, an Equity Mutual fund is the fund that collects money from investors and invests the same only into stock markets.


Okay, so what do you mean by SIP? SIP stands for Systematic Investment Plan (SIP). The idea of SIP is to inculcate a disciplined investment habit of investing fixed amounts at regular intervals. In the case of SIPs for direct equities or SIPs for mutual funds, it provides a benefit of rupee cost averaging. This helps an investor to buy more shares or units when prices are low and less shares or units when the prices are high.


Let’s now understand the two most common misbeliefs about Mutual Funds and SIP.


Misbelief 1: Equity mutual fund is far less risky than having direct equity exposure


Reality 1: Investing in Equity Mutual Fund has all the risk that Equity as an asset class has


A lot of mutual fund investors think that there is no risk to very little risk in  mutual funds. They can’t be more wrong on this. Just because the past long term returns for a set of schemes are good, many think that all mutual fund schemes are risk-free or very less risky. Even when an advisor suggests that the risks in equity mutual funds are same as that of buying a basket of selected basket of diversified stocks, the mental inclinations are not ready to take note of this point in any serious manner.


Equity mutual funds collect money from investors and invest the same in multiple stocks. Naturally, if the prices of those stocks goes up, the NAV of the scheme will go up. If the prices of those stocks goes down, then the NAV of that scheme will go down.


Though equity mutual funds are a good vehicle to invest and take exposure into equity markets, it still has all the risks that are applicable to equities as an asset class in general.


Misbelief 2: Most investors think SIPs are only applicable to mutual funds. Some also feel that SIP is a separate asset class.


Reality 2: SIP is just a method of transferring money periodically to any asset class. In other words, SIP is not an asset class but a method to make investments.


Many think and loosely speak words like, “I want to invest in SIP”. Most investors who say this are intuitively confused and think of SIP as some asset class. In reality SIP is just a method of transferring funds periodically towards a pre-defined financial product. There is no such thing known as “invest into SIP”. SIP is not an asset class but one of the method to buy an asset.


SIPs are not a new concept. It is just rebranded with this term. Ask any elderly about recurring bank deposits and it is same as SIP. If we extend the logic, paying EMIs are also a form of SIPs but the asset class is different. It is not for buying equity mutual funds but for buying real estate.


Equity mutual funds are one of the many ways to invest into stock markets. There are multiple advantages for an investor to choose equity mutual funds who does not have the skillset and time to find individual stocks and built a portfolio. However, it is important not to be misguided by misbeliefs. Else it can be quite dangerous in terms of financial planning and investing psychology.


To conclude:


  1. Investing in Equity Mutual Fund has all the risk that Equity as an asset class have. It is not less risky than buying multiple well research well selected stocks for a long period of time.
     
  2. SIP is not an asset class but rather a way to invest in various asset classes.
     
  3. The way “recurring” is to investing in “bank fixed deposit” and “EMI” is to repaying “home loans”, “SIP” is used to invest in “mutual funds”. Naturally, you can also do a SIP for investing into stocks of your own choice or through your investment advisors.

 



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