What are the Risk Factors involved In SIP?

A Systematic Investment Plan (SIP) is an effective way of investing in mutual funds(MFs). It eliminates the need to regularly time the markets while systemically building your wealth and assets.

The fund management companies invest your money in diverse instruments like debt, equities, bonds, corporate securities, etc. And as with any market-linked investment vehicle, SIPs also come with certain risks.

To become a well-informed investor, have a look at some of the risk factors involved with making an investment through a SIP.

What are Systematic Investment Plans or SIPs?

SIPs, or Systematic Investment Plans, are a method of investing in mutual funds in which investors allocate a fixed amount at periodic intervals, typically monthly. This disciplined approach helps build wealth gradually and benefits from the power of compounding over time. 

By investing consistently, investors can average out the cost of their investments, buying more units when prices are low and fewer when prices are high. This approach, known as rupee cost averaging, helps lessen the impact of market volatility and minimises the risk of making rash investment decisions based on short-term fluctuations. 

Risk of liquidity

Liquidity risk involves delays in getting back your investments. Typically, this problem occurs when the sale volume outweighs the number of security buyers in the market. As a result, sellers find it difficult to redeem the investment money to you.

Moreover, there can be schemes with a fixed lock-in period during which you cannot sell your investments. It’s also hard to sell low-performing MF units in the market, resulting in your money being stuck.

Market-associated risks

You’ve probably heard it countless times – ‘Mutual funds are subject to market risks’. The constantly changing market trends and price volatility directly affect a SIP’s Net Asset Value (NAV). A sharp rise in the market leads to profits while a fall signifies losses.

Several factors influence this price risk including interest rate variations, inflation, natural disasters, policy reforms, inflation, political activities, etc. Generally, the chances of earning profits increases proportionally with your holding period; i.e. the risk is lower when you invest for a longer period.

Additional Read: How to Top up Your SIP

Credit risk

Your MF portfolio value may also get exposed to credit risk. The value of underlying security falls if it faces a downgrade by a credit rating agency. Therefore, it negatively affects the overall value of your portfolio.

Depreciating investment value

Another risk factor of losses in SIPs arises when a scheme does not yield the expected returns. Your investment might depreciate with time if an MF has invested in underperforming securities and losing money. Thus, you will ultimately redeem lesser money than you had initially invested.

You can assess the fund management risk by looking at the past performance of an MF scheme. To plan a safer investment, you must do a SIP returns calculationbefore opting for a certain plan.

Technology risk

As most of the transactions take place electronically, there’s always a risk of failed transactions at multiple touchpoints. Although the non-processing issue is rare and can be resolved, it can still cause stress and loss of funds if not dealt with promptly.

Additional Read: Why are SIPs an Ideal Choice for the First-time Investor?

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FAQs

Are SIP returns taxable?

SIPs themselves are not tax-free. However, investments in Equity Linked Saving Scheme (ELSS) mutual funds, accessible through SIPs, qualify for tax deductions under Section 80C of the Income Tax Act. Investors can claim deductions up to Rs. 1.5 lakhs annually, depending on their total investments in eligible instruments.

Is SIP better than FD?

SIPs can offer higher returns than FDs due to market-linked investments in mutual funds. FDs provide guaranteed returns with lower risk. SIPs are better for long-term wealth creation, while FDs are suitable for risk-averse investors seeking stable returns. Ultimately, the choice depends on one’s risk tolerance and financial goals.

What is the risk factor in SIP?

The risk factor in SIPs depends on the underlying mutual fund. Equity SIPs are subject to market volatility and can be high-risk, while debt SIPs are relatively safer with lower returns. However, SIPs mitigate risk through rupee cost averaging and compounding, making them suitable for long-term investors.

Is there a chance of losing money in SIP?

SIPs involve investing small amounts regularly rather than a lump sum, potentially yielding better returns over time due to rupee cost averaging. The risk of losses in SIPs depends on the performance of the mutual fund where the SIP is invested. While SIPs can mitigate market volatility, negative returns are still possible if the fund's underlying investments perform poorly.

What happens if SIP fails?

If a SIP fails due to insufficient funds in your bank account, the investment for that particular instalment does not occur. Most fund houses allow a grace period for missed payments. However, consistent failures can lead to termination of the SIP. It's crucial to maintain sufficient balance to avoid such issues.​