SIP or Lumpsum

Introduction

A common predicament which an investor faces with respect to investing in mutual funds is whether to invest through SIP or whether to invest a lumpsum. This is especially the case when one has a significantly large corpus to invest as one may have either received an inheritance or landed up with a business windfall or secured a large bonus or redeemed the provident fund after several years of service. Thanks to the popularity of ‘Systematic Investment Plan (SIP)’, there are several investors who aren’t even aware that a lumpsum amount can be invested in mutual funds.

In this article we have tried to throw light on both these methods of investing.

Investing lumpsum

Lumpsum investing comes with extremely important caveats such as -

• Strong heart
• Ability to see our own hard-earned money in red
• Being there for a long haul
• Abundance of patience

Lumpsum investing also makes us bite the bullet by offering some hard realities. We have listed them below:

1. If we enter the markets when they are high, we may lose out on rupee cost averaging

   Rupee cost averaging is a way of investing, in which a fixed amount of money is invested on a fixed date, regardless of the stock value. The investors thereby end up purchasing more stocks when prices are low and fewer stocks when prices rise. In other words, we minimize the downside risk. By investing through SIP, we bear the advantages of the market volatility by investing in a phased manner. There are 248 trading days in a year. We invest in pre-committed 12 days out of 248 days by entering at different levels.

2. Lumpsum investing may diminish our wallet as we would invest at one go

   To earn Rs 50,00,000 in 10 year at a CAGR of 15%, one would have to invest a lumpsum of close to 16 lakhs. For most middle-class investors, Rs 16 lakhs is a significantly large amount. The opportunity cost of investing such a huge amount is also high and it may also put a lot of mental pressure on the investor. Investing lumpsum is tantamount to taking more risk and increasing the chances of going wrong.

3. We attempt to time the market, which in reality is impossible

   When we decide to invest in Equity Mutual funds, we have to brace ourselves to market volatility. Delaying investments with an objective to enter at lower levels is a common approach. In such a scenario, we try to time the market. We are unlikely to succeed. For instance, if one had invested in equity mutual funds in January 2008, then till December 2011 your returns would have been in red.

   Is it worth spending sleepless nights when such a scenario occurs? That is for an investor to answer. Regardless of good judgement, it is not always possible to consistently exit when markets are over bought and enter when markets are oversold.

4. Sometimes we receive a big bonus or a windfall gain and we end up investing the whole amount at a go.

   What should we do when we sell land, or receive a big bonus? Should we leave the money idle in the bank account? Or should we wait for the best entry time? Or enter the very next morning? Answer is No for all.

   We definitely do not want to risk our hard earned money. In the long run, markets will appreciate but we have a much better way for riding the cycle of the market.

   We can park it in Ultra short term funds and sign up for a Systematic Transfer Plan. This works similar to an SIP, where a fixed amount gets transferred from the Short term fund into our desired equity mutual fund.

5. Invest for the short term

   Before investing our lumpsums, we have to be extremely clear about our liquidity expectation. If we are going to need our money in two years for attaining a goal, we rather invest it in a short-term debt fund. Patience and calmness is the key to successful lump-sum investing.

6. May not be not suitable for goal based investing

   Goal based investing involves achievement of a target corpus on a specific date. If we invest a large amount at one go and if markets correct, we end up jeopardising attaining the goal itself. We also do not benefit from rupee cost averaging phenomenon.

   Investors who enter the tech sector and the funds linked to it in 2002, had to experience a 7-% fall in their NAVs. They had to wait for five year to see returns.

7. Inexperienced investors are likely to panic if market suddenly plunges

   Imagine a newbie investor, who hasn’t experienced market cycles, invests a large lumpsum at one go. Market volatility could result in drastic negative return with a very short period of time. This could not only cause immense stress to the new investor but also have an impact on one’s attitude towards investing.

Investing through SIP

SIPs offer a dream like experience in the investment journey. Some golden highlights are:

• Commitment into investing, thereby inculcating discipline
• Phenomenon of Rupee cost averaging

1. Helps you take advantage of market volatility

   In an SIP our funds are spread over time ensuring that only some portion of our investment would have entered at peak. This makes reduce our losses and enter at a low levels in the subsequent instalment. When the markets are low, the portfolio manager can buy more number of units as compared to when the market is at its peak. This automatically reduces our per-unit cost of buying the units. This is the great rupee cost averaging phenomenon. Ultimately, we end up with higher gains.

2. Doesn't dent our wallet as we are investing a manageable amount regularly

   One can begin one’s investing journey with as less as Rs 500 per month. As one’s income increases, one can slowly start increasing one’s SIPs. Investing through SIPs doesn’t burn a hole in the investor’s wallet. The focus should be on staying invested through volatility rather than starting one’s investment journey with bigger SIPs.

3. No need to time the market

   Market volatility is inevitable. We ought to ride the roller coaster of the market cycle. Under rupee-cost averaging, we end up buying more units when the markets are low. This not only contributes to a good discipline but also forces one to commit cash at market lows, when many other investors could be wary of entering. The mutual fund is taking care of our temptation to time the market, while we can relax and watch.

4. Suitable for anyone who is earning regular income

   Salaried individuals earn a specific sum of money on a monthly basis. Unfortunately, it is human psychology to create needs once the account is flushed with funds. Then in a blink of an eye, a pre-committed amount gets debited towards an SIP. Our wonderful mind readjusts to the created needs to the new cash available in our bank account.

5. Investing for long term

   Investing through SIPs are most appropriate to achieve long term goals. These could be goals related to creating a corpus for retirement or for building a fund to ensure higher education of children. Compounding ensures that the longer one is invested, the bigger the corpus becomes. Let us consider an example –

   If one invests Rs 5000 per month for 15 years at a CAGR of 18%, the resulting corpus is Rs 46 lakhs. However, if the investor stays invested for just another 5 years – which means the number of years has now become 20, the resulting corpus becomes an eye popping Rs 1.2 crores! A gain of close to 74 lakhs in just 5 more years!

6. Helps achieve goals

   An expert once said ‘Goal without a plan is just a wish’. SIPs throw light on how each and every goal of ours can we met. Prior to that, we need to list down our goals and set a target corpus to each of them. We then assume a reasonable rate of return and work out a monthly amount to be set aside. We are then on an auto-pilot mode to achieve our financial freedom and we stop following the herd.

7. Investor can train her psyche

   A famous on behavioural investing goes like this – ‘An investor’s worst enemy is not the stock market but his own emotions’. For several newbie investors, it is an altogether different experience to watch their portfolio in red, especially if one has been investing in volatile mutual funds such as small cap or microcap funds regularly over 24 to 36 months. However, if one invests through SIPs in mutual funds over a longer period of time, then one can witness how volatility is actually the friend of a long-term investor. This would be because rupee-cost averaging would reduce the cost of investment and as once the market starts rising then the value of the investor’s portfolio also rises. If an investor experiences multiple bull and bear cycles, then the psyche of the investor changes and becomes much more resilient than earlier.

What is best SIP or Lumpsum?

Thus, various aspects of investing through SIP and investing a lumpsum amount have been made clear to the investor. Depending on one’s financial circumstance and objectives, an investor can take a suitable call.