Mutual fund investors generally tend to throw in their towel at the first sign of volatility. This means that as soon as equity market volatility starts spiking and equity prices experience wide swings, investors become more inclined to stop their equity SIPs. This is the biggest mistake that they can make.
Systematic Investment Plan (SIP) is an investment vehicle that allows an individual to invest a fixed amount of money in a mutual fund school, at regular intervals. One of the main benefits of a SIP is that it precludes to time the market as investments are made regularly, at all market levels. This means that it allows investors to take advantage of volatility by averaging the cost of acquisition.
When markets are volatile or falling, your fixed SIP investment in the market will buy more units of the mutual fund scheme, thereby, lowering the average cost of acquisition and maximising returns over the long-term, once prices start moving up.
Let us understand this better with an example:
Assume that you have an equity SIP of Rs 10,000 monthly. On the day you start the SIP, the NAV of the equity mutual fund scheme is Rs 200, so you end up buying 50 units. Now let us examine two scenarios.
Scenario I: Prices are falling
Total units bought = 689
Average cost of acquisition = Rs 174
Scenario II: Prices are increasing
Total money deployed over the 12 months = Rs 1,20,000
Total units bought = 482
Average cost of acquisition = Rs 2490
Now, over the long-term, investors who have continued their investments through the scenario I will stand to generate higher returns than those investors who invested in scenario II but exited in scenario I.
This is no rocket science. An investment through a SIP can potentially generate superior returns only if you stay invested through multiple market cycles and do not let volatility drive you away from the markets.