SIP vs LUMP: Which Investment Method is Better
For most investors, this may not really be a choice. Typically, a lump-sum investment makes sense only if you have a substantial sum of money available in your hand to invest in one go. Otherwise, you are better off doing a regular Systematic Investment Plan (SIP) out of your regular income. Here are 5 things you must know about lump sum investing, before we move to getting the hang of SIPs.
- A lump sum investment makes sense if you have a large enough corpus on hand. A ballpark figure can be taken as around Rs.1 lakh.
- Lump-sum investment is vulnerable to market timing. If you invest lump sum at the peak of the market in equity funds, it may take you a long time to make profits
- Lump sum investing, logically therefore, works very profitably if you catch the bottom of the market and invest lump sum at that point.
- Lump sum investing exposes you to a number of risks like the risk of market timing, the risk of liquidity, the risk of volatility etc.
- Lump sum amount does not mean you have investment lump sum. You can also convert lump sum amount into SIP via a systematic transfer plan or STP.
Can you tell me about how SIPs gain by rupee cost averaging?
One of the common problems in lump sum investing is that you are already invested and don’t have liquidity on hand to capitalize on opportunities that may arise from time to time. That is why, if you are looking at a long term plan then SIP approach works better. It gives the added advantage of rupee cost averaging (RCA). This would obviously apply more in the case of SIPs on equity funds.
Let us get back to our concept of rupee cost averaging and how it helps. We already know that a lump sum investment will grow appreciably in a bull market but then the markets in reality are bullish for short periods of time and then it is volatile or directionless for long periods of time. So if you want to make a success of lump sum investing, you must buy at a long term market bottom. But that is not everybody’s cup of tea and the best of investors struggle to get timing right. Here, SIPs bring rupee cost average advantage. In a SIP, a standard sum is allocated each month for example. So when Net Asset Value (NAV) is up, you get more value and when NAV is down you get more units. This works favourably for your over longer periods of time as it reduces your cost of holding. That is rupee cost averaging
Great, but how exactly does rupee cost averaging (RCA) work in practice
Such things are best understood with a practical example. What we actually need to understand about SIPs is that they are all about rupee cost averaging and that is where they really score over lump sum investing. In the table below, we are using data for a live equity fund which is normally volatile over time. A monthly SIP of Rs.10,000 on the 10th of each month has been assumed over a period of two years. This table below will capture how rupee cost averaging works beautifully for the SIP.
| Month | Monthly SIP on ABCD Equity Fund | NAV on SIP date of 10th | Units Allotted | Cumulative Units |
|---|---|---|---|---|
| 1 | 10,000 | 11.00 | 909.091 | 909.091 |
| 2 | 10,000 | 11.55 | 865.801 | 1,774.892 |
| 3 | 10,000 | 11.20 | 892.857 | 2,667.749 |
| 4 | 10,000 | 10.55 | 947.867 | 3,615.616 |
| 5 | 10,000 | 10.44 | 957.854 | 4,573.471 |
| 6 | 10,000 | 10.33 | 968.054 | 5,541.525 |
| 7 | 10,000 | 10.25 | 975.610 | 6,517.135 |
| 8 | 10,000 | 9.80 | 1,020.408 | 7,537.543 |
| 9 | 10,000 | 9.70 | 1,030.928 | 8,568.471 |
| 10 | 10,000 | 9.35 | 1,069.519 | 9,637.989 |
| 11 | 10,000 | 9.10 | 1,098.901 | 10,736.890 |
| 12 | 10,000 | 8.70 | 1,149.425 | 11,886.316 |
| 13 | 10,000 | 8.55 | 1,169.591 | 13,055.906 |
| 14 | 10,000 | 8.65 | 1,156.069 | 14,211.976 |
| 15 | 10,000 | 8.25 | 1,212.121 | 15,424.097 |
| 16 | 10,000 | 8.85 | 1,129.944 | 16,554.040 |
| 17 | 10,000 | 9.35 | 1,069.519 | 17,623.559 |
| 18 | 10,000 | 9.45 | 1,058.201 | 18,681.760 |
| 19 | 10,000 | 10.55 | 947.867 | 19,629.627 |
| 20 | 10,000 | 10.85 | 921.659 | 20,551.286 |
| 21 | 10,000 | 11.25 | 888.889 | 21,440.175 |
| 22 | 10,000 | 11.15 | 896.861 | 22,337.036 |
| 23 | 10,000 | 11.55 | 865.801 | 23,202.837 |
| 24 | 10,000 | 11.85 | 843.882 | 24,046.719 |
With the above table on hand, let us compare the lump sum and the SIP and see how it would have worked out in both cases.
Option 1: Invested Rs.2.40 lakhs lump-sum in ABCD Fund
Here is how it would have worked. On the start day 2 years back, the investor would have been allotted 21,818.18 units at the NAV of Rs.11 for the Rs.2.40 lakhs invested. At the end of 2 years you are holding 21,818.18 units with a market NAV of Rs.11.85. In short, your investment of Rs.2.40 lakhs has grown to Rs.2.59 lakh at the end of 2 years. That is a return of 7.7% in 2 years, which is lower than what he would have earned in a savings bank account.
Option 2: What if you had instead done a SIP of Rs.10,000 per month for 2 years
Here you would have got the full benefit of the NAV volatility and would end up with 24,046.719 units at the end of 2 years. At a NAV value of Rs.11.85, this translates into a total value of Rs.2.85 lakhs. That is an IRR of 18.73% over a 2 year period. The difference comes from the fact that due to volatility; you end up with more units at the end of 2 years for the same investment thus enhancing your returns. That is how rupee cost averaging works.
Am I better off with SIPs if I start earlier?
No doubt about that. You would be surprised that if you start early, then even with a smaller monthly SIP amount, you can end up with higher returns. That is the power of time in SIPs. The earlier you start, the more your principal earns returns and therefore the more your returns earn returns. That is called power of compounding. It is the time period that makes the biggest difference to your wealth and not just the amount you invest or the rate of return. The table below will explain things in detail
| Particulars | Alpha | Beta | Kappa | Omega |
|---|---|---|---|---|
| Starts SIP at age | 25 | 30 | 35 | 40 |
| Ends SIP at age | 55 | 55 | 55 | 55 |
| SIP Tenure | 30 years | 25 years | 20 year | 15 years |
| SIP Amount | Rs.5,000 | Rs.10,000 | Rs.15,000 | Rs.20,000 |
| CAGR Yield | 12.5% | 12.5% | 12.5% | 12.5% |
| Total SIP Outlay | Rs.18 lakhs | Rs.30 lakhs | Rs.36 lakhs | Rs.36 lakhs |
| SIP Value at 55 | Rs.197.42 lakh | Rs.207.53 lakh | Rs.160.43 lakh | Rs.105.88 lakhs |
| Wealth Ratio | 10.97 times | 6.92 times | 4.46 times | 2.94 times |
The above chart shows how the SIP can vastly outperform when you start early. In the above instance, Investor Alpha runs her SIP for a period of 30 years and therefore wealth ratio is 10.97 times the original investment. On the other hand, Beta is able to create a wealth ratio of just 6.92 times despite higher investment outlay. The reason is longer time period. When you do a SIP, you actually make time work in your favour.
Above all, SIPs are a practical answer to your financial goals
The real advantage of SIP over lump-sum investing is that it makes time work in your favour. That is because, over time markets tend to be volatile and the benefit of rupee cost averaging makes this time factor work more in your favour by reducing your cost of holding and enhancing your return on investment.
But there is a more practical aspect to SIPs in that most people have income flows that are regular in the form of salary, wages, commissions, pay-outs etc. When you do SIP, you do not burden your finances and synchronize better with inflows. Since, you start off with your financial goals in mind and work backward you get a clear view of how much you need to invest. That also allows you to adjust and tweak your monthly budget accordingly.
So, that is how SIPs score over lump sum investing in the long run. To sum it up, if you are comfortable taking a view on the market and allocating funds accordingly, then lump sum investing can suit you. If you want a more passive approach, then SIP is a better choice for you. It normally works in all market conditions.