The story goes like this. There were two bachelors living in the city of Bengaluru. One was getting his income monthly and gave the landlord a portion as rent. Whereas the other gave a whole deposit for the accommodation for a fixed time of stay. Now what does the two have in common and what do they have in distinction? Who has the better deal? This is the same as choosing on to take a lump sum investment or a SIP (Systematic Investment Planning) in a Mutual Fund investment.
What are they?
SIP is like small drops that form an ocean of savings, which allows you to save your money little by little and builds it up over the course of time to give you the big pot of wealth in the end. SIP is an investment in a fund of a fixed amount of money at a fixed frequency of time, generally in months. SIPs give a neat solution to the main problem that most investors face in this day and age, I.e. the choice of making an investment based on the investors’ risk and return scale (investment profile) and his capacity of investment that includes his income, expenditure, financial goals. With a SIP one can make sure to not miss out on getting the best possible returns from mutual funds. Depending on the in affordability, you can choose to invest through a regular SIP or lump sum in one go.
A lump sum is the ocean bed itself. One makes a lump sum investment when the entire amount can be invested at one go into a chosen mutual fund. Lump sum investments are done mostly by those who can afford to put the big pot of money in the beginning and have a better understanding of the markets and current valuations or investors with the financial advisors who do the homework for them.
What makes them different?
With lump-sum investing, you have the money in hand that can be invested. Whereas in case of SIP, you may not have a huge sum on hand but can make regular deposits. If you do not have a lump sum of money available to invest, there is no question of you having to invest at one go. Similarly, if your future income is uncertain, SIP is out of the question.
When you make a lump sum investment, you will see gains only when the net asset value (NAV) of the stock or the fund, you will gain only when the NAV moves up. Hence, lump sum investments may work nice for you, if you are able to invest at the bottom of the market cycle. In the case of SIP, the same amount of money is invested periodically, say monthly. The average cost of your investment is reasonable and accumulates more units than what you get through lump sum investment over a period of time through the concept called rupee-cost averaging, which works by keeping the cost of acquisition lower, resulting in higher gains at the time of redemption.
SIPs are quite immune to the volatility of the markets as compared to Lump sum investments which are subjected to the market’s fluctuating conditions.
Which gives more profit?
The pity with a Lump sum investment is that works well when you invest at the bottom of the market cycle but nobody can say when the market would hit the bottom and you could lose out a lot of opportunities just by waiting for that elusive bottom. SIPs, on the other hand, invests your money as the market continues to fluctuate. Some of the investments may be at a higher NAV and some at lower NAV. When the NAV is higher, your fund value will go up, but you will get a lower number of units as the price is high. But when it is low, your fund value will decrease, but you will have a higher number of units as the price is low. This makes for a reasonable average cost of investment. This is what is called rupee-cost averaging, which works great for SIP by keeping the cost of acquisition lower, resulting in higher gains at the time of redemption.
How do they work?
Let’s take an example, Neha makes a lump sum investment of Rs 1,00,000 at a NAV of Rs 500 and gets 200 units while Sameer invests Rs 10,000 over 10 months at NAVs of Rs 500, Rs 550, Rs 500, Rs 400, Rs 200, Rs 250, Rs 350, Rs 400, Rs 500 and Rs 600 and gets 20, 16, 20, 50, 25, 40, 28, 25, 20 and 18 units respectively. So, the total number of units Sameer gets through 10 installments of SIP is 263 units, which is more than 200 units that Neha got through lump sum investment. Average NAV at which Sameer invested his money is just Rs 425, while that of Neha is Rs 500.
Suppose if they both redeem their units at a NAV of Rs 800, Neha will get Rs 1,60,000 (i.e. Rs 800×200), while Sameer gets Rs 2,10,763 (i.e. Rs 800×263.42) with the same investment of Rs 1,00,000. But if the market rises continuously in a linear way like with FDs or debt funds, Neha would gain more as each subsequent investment Sameer makes will be at a higher NAV, resulting in accumulation of a lesser number of units and lesser return.
So, SIP is better than a lump sum for investments particularly with equity exposure, where the NAVs fluctuate, giving an opportunity for you to gain higher returns through periodic investments. But it is important to keep a few things in mind. Choose the amount that you want to invest periodically into the target equity mutual fund based on your saving capacity, income and expenditures. Once that is done, your investment remains the same irrespective of whether markets go up or down and the NAV of the fund will change as per the fund’s performance and prevailing market conditions.
Which one is better? SIP? Lump sum? Or Both??
Apart from the fact that SIPs make more profit, they are also great psychological help while investing. Investors have a natural tendency to time the market when there is equity exposure. So when the market falls, instinct makes them sell and stop investing and when it rises, they invest more. This is the opposite of what should be done. A SIP puts an end to all this by automating the process of investing regularly, eliminating the mental load of deciding when to invest.