Mutual Funds Intermediate

The pitfalls of mutual fund SIPs: A guide for small-cap investors in volatile markets

Pitfalls of mutual fund SIPs

Mutual funds are run by companies that pool investor funds, creating a mutually beneficial investment. The fund manager who collects the funds invests them in stock markets, bonds, and short–term debts. This helps yield better returns while minimizing risks. Given all of these amazing benefits, people love to invest in them. And mutual fund investors with limited money opt for Systematic Investment Plans or SIPs, which allow you to invest a small fixed sum each month/year. But what’s the flip side of SIPs for small-cap mutual fund investors?

Understanding small-cap investors and volatile markets

Small cap refers to a small company that has low market capitalization figures. The better profit opportunities that come with investing in small-cap stocks are the main advantage.

What are small-cap investors?

Small-cap investors are those who invest in young companies and startups. The companies are publicly traded companies on the stock market.

Those who invest in small caps are usually seeking growth, which they do offer. But they also come with significant risks and volatility. So to be a good small-cap investor, one has high-risk tolerance and plenty of patience.

How does volatility affect small-cap investments?

Those investing in small caps need to be aware of the risk and volatility that comes with them. The stock market’s price fluctuation tends to heavily influence these stocks, so they can be rather volatile. The stocks do tend to perform well when the market is on an uptrend and underperform when the economy is down.

When the stock market bounced back post-Covid, for example, small-cap mutual funds delivered great returns. The Nifty benchmark index for small-cap funds, for instance, offered 114% returns at the time. However, soon after, small-cap funds crashed with the Ukraine crisis unfolding. This was, again, simply a reflection of the broader scenario.

Such stocks also usually require some solid marketing. And while that does help the stock price rise, it makes the stock more susceptible to market risks such as volatility.

During moments of volatility, it is tempting to make some common mistakes with SIP mutual funds. Because small caps are less liquid than large-cap shares. But markets are known to be volatile, so it helps to be prepared.

Common mistakes in mutual fund SIP investing

Investing in mutual funds often does help with getting good returns, but it takes time. Also, if you choose a mutual fund with short-term debt, it will yield lower returns. So while investing in mutual fund SIPs, one needs to exercise a certain degree of caution and try to avoid some common mistakes. Especially so with small-cap investing.

  • Neglecting to monitor the SIP: Sure, there is a fund manager to do this, but make sure you know where you are putting your money too. This will help you stay motivated and know when to pull out.
  • Not linking the SIP to a specific goal: When you don’t link the SIP to a specific goal mentally, you’re leaving the door open for lack of motivation to creep in.
  • Short time frame: You need to give your fund time to grow. To learn how the duration of your investment can make a big difference, read this.
  • Aggressive SIP timing: If you don’t time your SIP in a manner that works for you, the chances that you will skip payments are higher.

In addition, it also helps to keep the common drawbacks of SIP investing in mind before you sign up. This will help you hold on.

What are the common drawbacks of SIPs for mutual fund investors?

The SIP mutual fund investment process is simple. But there are some common drawbacks associated with it.

For one, SIP returns can be lower in a consistently rising market, and the SIP date may work as a limit. Plus, even if you find the best mutual fund for SIP investing, you will have to wait one month to start investing. The predefined amount of the SIP can also act as a barrier at such times.

Additionally, there is the issue of stopping the payment. Unforeseen circumstances may force you to do it, and then you will lose money.

Sometimes, poor trade execution can stunt the mutual fund’s performance. As a result, there may be a lag in its performance compared to the market.

Finally, the SIP option usually does not suit people with unpredictable cash flows, such as freelancers. It is important to keep these drawbacks in mind before investing in SIPs.

Avoiding mistakes in small-cap mutual fund SIP investing

Before you invest in a mutual fund SIP return calculator, invest a few minutes of your time reading this section carefully.

  • Making small-cap funds a part of the core portfolio: Your core portfolio should consist of large caps, indexes, and other less risky assets. Small-cap mutual funds SIPs are best reserved for the satellite part.
  • Late entry: This defeats the purpose of SIPs. The sooner you begin, the better.
  • Lack of discipline while investing: Skipping your installments will only put you in a bad spot. You need to be disciplined, so your SIP stays functional.
  • Investing in really cheap small-cap stocks: If the stock prices fall because of a crash, chances that the really cheap ones may not recover at all or enough. It’s safer to pick small caps that are cheap but have a better chance of recovery.
  • Stopping the SIP due to market weakness: The point of SIPs is to get you to hold on. Remind yourself that you can accumulate more units when stock markets are down and fewer when markets rise. Panic selling has more disadvantages than advantages. Instead, think about creating a backup plan to help you handle crashes.

Always avoid risk plans if you are a risk-averse kind of person. In mutual funds, there is bound to be some risk, but you can plan according to your needs and temperament. Choosing the best fund for a SIP for you will help you stay committed.

How can small-cap mutual fund investors avoid pitfalls in mutual fund SIP investing?

Before investing your money in small caps, study them and the underlying business idea well. Make sure they have the potential to register gains. Additionally, it helps to:

  • Be clear about your strategy,
  • Set aside time to monitor the funds, and
  • Work on learning to accept some risks and developing a positive mindset

Strategies to minimize risk in small-cap mutual fund SIP investments

Investing in small-cap mutual fund SIP plans are a great way to invest in young companies and startups. You would, however, do well to address the risks of small-cap mutual fund investments. To sum up, what we’ve discussed so far, some strategies that may help are:

  • Planning and maintaining discipline,
  • Restructuring your portfolio periodically,
  • Diversifying your portfolio, and
  • Fixing long-term goals.

Conclusion

Mutual fund SIP returns are great, but they do come with some risk. Choosing the right mutual funds will help to some extent. Also, always keep your personal financial needs and goals in mind while planning investments.

Disclaimer: Investing in mutual funds is subject to market risks. Please read all scheme-related documents carefully before investing. Potential returns from a mutual fund product are not guaranteed. Past performance is not indicative of future results. None of our articles are intended to and should be considered investment/financial advice from CoinSwitch.

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