Sip Vs Lump Sum: Which Is The Better Investment Option?
Let us start with a small riddle. In March 2020 the Nifty was at 25,700. In October 2021, Nifty touched 60,000. What would have been a better choice for you in March 2020; lump-sum investing or systematic investment plan (SIP) investing? Obviously, you would have been better off investing lumpsum in March 2020 because then your equity funds would have been up 133.5% over the last 20 months. However, in SIPs, your returns would have been lower since you would be consistently buying at higher levels each month.
What is wrong with the above argument?
If you look at our above case, it looks like lumpsum investing is clearly a better option. But there are reasons why this conclusion could be flawed. Let us look at some of them.
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The assumption is that you make the lump-sum investment at the bottom of the market. As we have seen, identifying such bottoms is easier said than done.
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Secondly, the assumption is you held on for 20 months. Normally, if an investor had earned 30% in 4 months, they would have certainly exited by now.
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We are just looking at just a 20 month period but financial planning is about a period of 20-25 years. Catching bottoms of the market is tough over 20-25 years consistently.
It has been observed in India and in other countries that finding tops and bottoms of the market is not only tough but also not necessary. Instead, if you consistently save through systematic investment plans (SIPs) of equity funds, you would be better off.
Investing Lump-sum Versus Sips: How Are They Different?
If you have a relatively large sum of money say Rs.5 lakhs available on hand, you can invest in lump-sum. For most others, the mutual fund investing is all about saving out of their regular salary or income so the SIP would work a lot better for them. Let us look at lump-sum investing and SIPs in greater detail.
How Does Lump-sum Investing In Mutual Funds Work?
If you want to invest a lump sum amount in a mutual fund, you can make a one-time payment as lump-sum investing in a fund. For example, if you have Rs.500,000 that you are willing to put away for the future, you can invest the money in mutual funds as a lump sum or a one-time investment. There is no regularity to such investments.
A lump sum investment is most suitable for persons with a significant amount of money that is readily available at their risk. Lump-sum investing also calls for the investor to have considerable risk tolerance to invest that money in its entirety in one go. Normally, when it comes to lump-sum investing, the timing of entry matters a lot.
How Does Sip Investing In Mutual Funds Work?
The more popular way to invest in mutual funds is through Systematic Investment Plan or SIPs. A SIP is based on the principle that “little drops of water make the mighty ocean, and little grains of sand make the vast land”. Even a salary earning middle class employee can participate in the equity markets in a small but effective and meaningful way. In a SIP, the investor makes regular monthly investments of a fixed amount on a pre-decided date for as long as they intend to continue the SIP.
In a SIP, instead of making a lump sum investment, you can start a SIP of small amounts each month. Let’s say you start a SIP of Rs. 5,000 for three years. Every month, on the specified date as fixed by you, Rs.5,000 will be automatically deducted from your bank account and equivalent mutual fund units will be allotted based on that day’s NAV. SIPs are extremely effective in long term financial planning and give rupee cost averaging benefit. That means over a longer period of time, they reduce your average cost of holding the MF.
Tell Me Which Is A Better Option: Lump-sum Or Sip Investing?
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Let us first look at the benefit of rupee cost averaging. SIPs keep investing irrespective of how the market is behaving. In a good market, you fetch more value and in a bad market you fetch more units. Either ways, you benefit in the long run. This reduces your per unit cost over time. However, in the case of lump-sum investing, the timing and level of entry are extremely important as that determines your long term returns.
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Which of the two; SIP and lump-sum is simpler and more effective? Timing the market is essential when investing a lump sum amount because you do want the most value for your investment. However, timing the market is a tricky job and even the best of investors don’t normally get it right. However, a SIP is relatively simpler even for those who are not tuned into stock markets. This makes SIP a very good option for new and inexperienced investors.
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Thirdly, we all know that successful investing is more about discipline than about guessing the market right. That is again an area where SIP scores higher. A lump sum approach to investing in mutual funds is very arbitrary. You may catch the market wrong, you may unnecessarily average or you may exit too early. All these are against the concept of discipline. SIPs invest a fixed amount each month, which is a more passive and disciplined approach. It also instils the savings habit early in people.
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What works better for a financial goals? This is perhaps the most important. Financial goals like retirement, child’s education etc are long term goals and you need to plan for them systematically. It is best done by monthly allocations via SIP. The rupee cost averaging in SIPs works to your advantage and gradually takes closer to your financial goals.
Finally, I Have Rs.3 Lakhs, Can I Do A Sip?
An interesting question, but the answer is Yes. They are called Systematic Transfer Plans or STPs. Here is how they work. You invest your Rs.3 lakhs in an income fund or liquid funds that holds value, Then each month you sweep a fixed amount, say Rs.5,000 or Rs.10,000 into an equity SIP. This way, you earn interest on your income fund and also get the benefit of an equity SIP. You don’t really have to make a choice between lump-sum and SIP investing. You can actually meet mid-way.