When investing in mutual funds, you can choose to invest via the lumpsum method or a systematic investment plan (SIP). While a lumpsum investment involves investing a large amount at once, SIP allows you to spread out your investment over a period of time. This choice of investment method can have an impact on the your overall investment portfolio. To understand how, let's take a closer look at both options.
Understanding SIP and Lumpsum Mode of Investment:
You can use both SIP and lumpsum methods of investment to potentially create wealth through mutual funds. The key difference between the two methods is the investment frequency. While SIPs involve periodic investments, such as daily, weekly, monthly, quarterly or half-yearly, lumpsum investments are a one-time bulk investment in a particular mutual fund scheme. The minimum investment amount in each of the methods also varies, with SIPs allowing investments as low as ₹500 per month, while lumpsum investments generally requiring at least ₹1,000 to start with. If you can invest a fixed amount at regular intervals, SIP may be a more suitable option for you. Conversely, if you have a relatively high amount of money available for investment and a high risk tolerance, lump-sum investments may be more beneficial.
Factors to be considered while deciding which investment method to choose:
1. Amount available for investment:
There can be various situations when you may receive a lumpsum sum of money. For instance, you may receive a lumpsum amount of money as an inheritance from a family member who has passed away. If you are an employee, you may receive a lumpsum amount as a bonus or commission payment for meeting or exceeding performance targets. You may have sold a property, such as a house or a car and received a lumpsum amount of money from the sale or you may have won a lawsuit and received a lumpsum amount as a settlement or you may received a lumpsum amount of money when you retire. The decision of investing such lumpsum money needs to be made cautiously. In such situations, a lumpsum investment could be a wise choice since you have a considerable amount of money and would want to prevent overspending and explore investment opportunities to make the most of the money. However, if you are a salaried individual who has regular income and aims to develop a savings routine, SIP may be a more suitable investment method for you.
2. Ability to time the market:
When deciding to invest lumpsum there is risk of market volatility involved which means that there is always a possibility of market declining after you are fully invested and there is a market correction. If this correction marks the start of a bear market, you would miss out on the return or generate negative returns till the market recovers and your investment is back at cost value. However if the same amount is invested towards the end of a bear market or start of a bull market, you can earn potentially earn higher returns on your lumpsum investment. You must have a clear idea of market conditions before making lumpsum investments as they require a significant commitment of funds. These types of investments are more advantageous if made during a market low. Thus if you are able to precisely time your entry into the market, you can make handsome returns on your lumpsum investment.
However, if you are unable to identify market cycles and are unsure when to invest, SIP may be the best option for you. SIP allows you to invest a fixed amount at regular intervals, which helps to average out the cost of your investments over time and thus helps to distribute the risk and potentially earn better returns in the long run. SIP should also be your preferred option if you want to instill the habit of saving regularly in yourself.
3. Flexibility of investment:
SIP allows you to invest a fixed amount of money at regular intervals, which can be automatically deducted from your bank account. One of the benefits of SIP is that you can pause or cancel the SIP investment if you have a short-term financial requirement, such as an emergency expense. This allows you to access your funds when you need them while keeping your earlier investments intact.
However, if you are accumulating money to invest in lumpsum in the future, having the money readily available could tempt you to spend it instead of saving and investing it. In such a case, SIP may not be the most appropriate investment option as it may not prevent you from accessing your funds.
Arguments in favour of investing via SIP Method:
By providing the option to invest small amounts, SIPs enable you to start investing with as little as ₹500 per month. While it may seem like a small amount, the truth is that over time, these regular investments can accumulate and grow your wealth significantly. With the power of compounding, even small monthly investments can lead to a substantial corpus in the long run.
Taking small steps can actually lower your risk, especially when it comes to mutual fund investments. Starting your investing journey with SIP means that even if you make some mistakes in your investment decisions initially, the impact would not be significant as only a small amount of money gets invested on a regular basis. On the other hand, waiting to accumulate a lumpsum amount before investing in mutual funds could result in missing out on potential growth opportunities.
Maintaining financial discipline can be challenging, especially when it comes to adhering to an investment plan. The unpredictable nature of the stock market and the lure of spending money can divert you from your financial goals. To overcome this challenge, a SIP can be a valuable tool. By automating the process of monthly investment using the auto-debit facility provided by your bank, you can avoid the temptation of spending over investing and gradually develop financial discipline which can be instrumental in achieving long-term wealth creation.
Diversification is an important aspect of investing. Investing in multiple asset classes or sectors helps to spread the risk and minimize losses in case of a market downturn. SIPs can provide diversification by investing in a mix of funds or stocks. This diversification reduces the risk of losses as compared to investing a lumpsum in a single stock or fund.
SIP is an effective tool for reducing investment risk, mainly due to the concept of rupee-cost averaging. It provides the opportunity to purchase more mutual fund units when the market is down and fewer units when the market is up. This approach helps to mitigate risk by averaging out the investment over time and this makes SIPs the best option for managing the volatility associated with equity investment. Through SIP investments, you can protect yourself from significant losses and stay committed to your investment journey. If you are able to remain invested over a sufficiently long period, SIPs can prove to be a reliable means of achieving satisfactory returns.
SIPs instill discipline in investing. It helps to avoid the temptation of timing the market and making emotional decisions. It helps you to stay invested in the long run and not get swayed by short-term market volatility. It is an excellent way to create wealth in the long term with regular savings and systematic investing.
When investing via SIPs, you do not need to monitor market movements as closely as you would for lump-sum investments, where investing at the market low is most beneficial and any ill-timed lumpsum investment could result in loss of money and confidence. SIPs thus provide you with the flexibility to enter the market at different stages of the market cycle since you invest a fixed amount at regular intervals.
Arguments in favour of investing via Lumpsum Method:
One of the underlying assumptions of SIP investing is that the current market is overvalued and therefore, it is expected to decline over a period of time before rebounding. This explains why investments are made in staggered amounts to have more funds available when the market goes down and to average the cost of investments when it rises again. However, this is not always the case. There have been instances where the market has risen steadily for years without any significant downturns. In such situations, investing in lumpsum would have yielded better returns than investing via SIP. This is because rupee-cost averaging tends to provide suboptimal returns during periods of high market growth as you may end up buying fewer mutual fund units at lower prices and more units at higher prices given the uptrend of the market.
A major drawback of investing through the SIP method is the complexity involved in evaluating your investment's performance. While you can calculate the returns on lumpsum investment using basic arithmetic, calculating SIP returns is more challenging as investments are made in a staggered manner over extended periods of time. Critics argue that you may not be able to accurately determine the true returns of your SIP investments due to the impact of compounding. Additionally, the rate at which the investment compounds may also not be as attractive as expected.
You may earn lower returns when you invest through SIPs if you believe that the manner in which you invest is more important than the funds in which you choose to invest. Investing through a SIP in an underperforming fund fails to optimize the benefits of rupee-cost averaging in SIPs, thus giving you sub-optimal returns. To make the best out of your investments, it is important to invest in a consistently well performing fund.
Investing using the lumpsum method can result in lower transaction costs, including brokerage fees, annual maintenance fees and other charges imposed by mutual funds as compared to SIP investments. Lower expenses can contribute to achieving higher investment returns over time, particularly if you plan to remain invested over the long term.
In general, you must choose an asset allocation strategy based on your individual needs to maximize your returns. If you can take on more risk, you can consider a more aggressive allocation to equities, while if you have a lower risk tolerance can opt for a more conservative strategy involving a higher allocation to debt. However, following an asset allocation plan can be challenging when investing through the SIP method. Investing via SIP involves investing a fixed amount of money at regular intervals and this can result in a significant amount of cash reserves left with you that may not align with your desired asset allocation. Failure to adhere to an asset allocation strategy and delay in putting your money to work can affect achievement of your financial goals over the long run. Therefore, it is essential to carefully consider the impact of your investment method on your asset allocation and adjust your investment plan accordingly to ensure that it aligns with your long-term financial goals. By doing so, you can optimize your returns and minimize the risk of losses.
If you have a substantial amount which you wish to invest in equities or equity mutual funds but do not wish to commit the whole amount at once, you could invest the lumpsum amount in a debt fund and opt for Systematic Transfer Plan (STP) into an equity fund of your choice. This is because debt funds are not affected a lot by market volatility and give similar returns for lumpsum and SIP investment. This way you could enjoy the benefits of rupee-cost averaging provided by SIP and also earn better returns than keeping your money in your bank savings account.
Conclusion
There is no definite answer as to whether SIP or lumpsum investment is better, as the choice of the investment method would depend on your individual financial goals, investment horizon and risk appetite.
A lumpsum investment may be more suitable if you have a large amount of money available and are looking to invest it for the long-term. This method can potentially yield higher returns as the entire sum is invested upfront and has more time to grow. On the other hand, SIP can be a better option if you want to invest small amounts regularly over a longer period of time. This method can help to average out the cost of investment and reduce the impact of market fluctuations on the overall returns. Both the investment routes discussed above have their own advantages and disadvantages. Experts generally suggest SIP route over lumpsum investment as it inculcates a habit of saving which is necessary for wealth creation in the long run and helps to tide over short-term market fluctuations. However, if you do not follow equity markets regularly then lumpsum investment in debt fund along with STP to equity fund as discussed above, could help you distribute risks.
The decision of whether to opt for an SIP or a lump-sum investment should thus be influenced by your individual needs and circumstances. Besides, you should also take into consideration your income, financial situation, investment objectives and ability to handle risk when determining which investment approach is appropriate for you.
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