SIP vs Lumpsum
Types of Investors and Which Mode They Should Choose
An increase in awareness about Mutual Funds has brought more and more investors closer to the investment world. Investing is all about making the right decisions at the right time and one of the first decisions budding investors face is whether to employ a Systematic Investment Plan (SIP) or go with a Lumpsum Investment.
What is SIP?
A SIP is a plan in order to make systematic investments at regular intervals of time.
When you subscribe to a fund through the SIP route, periodic payments go into the fund from your bank account. Let’s say you want to invest a total of ₹1,00,000 in small bunches of ₹5000 a month in large-cap equities. In order to do so, you would have to subscribe to a SIP of a large-cap mutual fund and mention your monthly payments, here, ₹5000. Once you do this, ₹5000 is automatically invested in the fund from your bank account every month.
Advantages of a SIP:
- Dollar-Cost Averaging
When you invest in a mutual fund, you essentially buy ‘units’ of the fund.
Number of units you buy = Amount of money you’re investing / Current NAV of the fund
The denominator of the above expression, NAV of the fund, keeps changing and generally follows the market. If the markets are going up, the NAV increases and if markets are going down, the NAV decreases. So, when you’re investing through the SIP route, the net NAV will be the average of all the NAVs at buy time. If you are unlucky and invest at the peak, there is no need to worry as moving forward you will be buying more units at lower prices and hence your net NAV gets averaged out. The NAV will be relatively low in some months and you can accumulate more units of the fund. This effect comes into play especially in highly volatile or bears phases. In these situations, you have a good chance of continuously accumulating more units at lower and lower NAVs. This would not have been possible if you invested your entire ₹1,00,000 before the bear phase started.
- Can Be Synchronized With Salary Receipts
You can design a SIP such that a certain fixed amount of money gets invested in mutual funds as soon as your salary gets credited into your account. This way, you will develop an investing discipline and won’t end up spending the money you were supposed to invest.
- Market Timing
If you choose a SIP, you won’t have to worry about timing the market, Dollar Cost Averaging will help you average out your ‘unit’ prices even if you happen to start investing at the peak of the market.
- You can cancel the SIP anytime and make way for emergency expenses whereas liquidating lumpsum investments to meet immediate needs might lead to additional costs.
Disadvantages of SIP:
- In high growth or bull phases, you will miss out on the power of compounding which would have exponentially grown your investments if you had chosen the lumpsum route.
- Only a fixed amount of money gets invested every month and you can not increase your investments for a month if you feel valuations are low at any point.
- You always need to maintain balance in your bank account on the SIP date so that the money can get invested
What is Lumpsum?
In lumpsum investing, you would invest your entire amount at once. Considering the example used above, you would be investing your entire ₹1,00,000 at once if you choose lumpsum investing.
Advantages of Lumpsum:
- Power of Compounding
By investing through a Lumpsum route, you are giving all your money more time to grow itself. Continuous positive fund returns will grow your wealth substantially in no time.
- Spending Urge Limited
As all your money gets locked up in the fund at once, there is no way you can get tempted to spend your money elsewhere.
- Market Timing
If you manage to time the market transition from bear to bull phase perfectly, then you’d be buying lots of fund ‘units’ at low NAVs and the power of compounding in the bull phase will be able to work its magic.
Disadvantages of Lumpsum:
- Timing the market is usually very difficult and you might end up investing amidst a bear phase.
- If you are unlucky and invest at a market peak, there is no dollar-cost averaging to save your money.
- If a crisis occurs in the middle of your investment horizon, you might panic and get tempted to take your money out, which is the worst possible thing you can do. This won’t happen in SIPs as you wouldn’t have invested half your money yet and have a good chance of investing at a market bottom.
Investors should first focus on determining their investment goals and their current financial position before choosing between a SIP and Lumpsum Investing:
- Cash Rich Long Term Investors
If you are an investor who has a lot of cash sitting idle and wants to invest it for a long period in order to beat inflation or generate higher returns than offered by banks, then you should consider the lumpsum route.
In a longer time horizon, the effect of any crisis is neutralized by the recovery and also the power of compounding. For example, ₹1 lakh invested in a NIFTY 50 Index tracking fund in May 2000 would have resulted in a corpus of over ₹6.5 lakh exactly 20 years later despite the 2008 Financial Crisis, the NBFC Crisis of 2018 and the Coronavirus Pandemic.
2. Young Investors With No Substantial Savings
If you are just starting your investment journey, then a SIP is perfect for you because it will help inculcate an investing discipline in you. Since you might not have the skill to time the market, dollar cost averaging will come to your rescue even if you invest at the absolute peak of the market.
3. Short Term Investors
If you want to invest for a short-term, then you should always prefer a SIP unless you are a master at timing markets. A crisis might occur just after you invest and wipe out your capital if you choose lumpsum. A SIP will help you reduce your net NAV and you will hence end up in a better position as compared to lumpsum investing if a crisis occurs. Also, the primary advantage of lumpsum investing, the compounding effect, is not as powerful in the short term.
Case Study
2014–2019: Bull phase - Lumpsum outperformed SIP by a big margin when tested using the historical NAVs of Axis Bluechip Fund, which has been performing excellently well over the past few years. This was because of the compounding effect.
2007–2012: Crisis-hit phase - SIP outperformed lumpsum in this case when tested using historical NAVs of Franklin India Bluechip Fund, which was one of the best performing funds in this period. This was because the time horizon is not very long and there was not enough time for the money to compound post-crisis.
Choosing the right mode to invest therefore depends on your risk appetite, the time horizon of investing and also on how much initial capital you have. So, make sure to include all the above-mentioned points in your decision-making process in order to maximize your expected returns.
Notes:
- You can manually follow a SIP like plan for your direct equity investments as well.
- Value Averaging Investment Plans and Systematic Transfer Plans are to some extent hybrids of SIP and Lumpsum Investing and can be looked into as well.
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