SIP vs Lumpsum

SIP is one of the most advocated way of investing in mutual funds. Without doubt SIP is a good tool for systematically accumulating a corpus by investing with market-linked investments for future goals. In this article we look at why or under what circumstances is SIP is a better way to invest. We will be illustrating our thoughts with numbers.

Firstly what is SIP?

SIP stands for Systematic Investment Plan, a mode of investing in mutual funds that allows one to invest fixed amounts in a specific mutual fund scheme for regular periods. It makes regular investment convenient with the auto debit facility, and affordable with a low minimum investment requirement. SIP doesn’t incur any additional charges.

However if we were to compare both lump sum and SIP mode of investments, one should understand that the performance of the particular investment will depend on the market conditions at that time and if it is invested for long term or short term in case of lump sum and cost averaging in case of SIP. Cost averaging results in an investment being purchased at an average cost spread over a period of time instead of one cost on a single day, which could be higher than or lower than the average.

Here is a demonstration of how these two factors could affect your investments –

SIP does not assure a profit or guarantee protection against loss in a declining market and should not be construed as a promise, guarantee on or a forecast of any minimum returns.

Thus investing in SIP generally one would get fewer units when price is high and more units when price is low.
However the table above also makes it obvious that the game would favour lump sum investment had it been made when the unit price was lowest (generally when the equity market is down). In such a case the investments would look like this, all else remaining the same.

SIP does not assure a profit or guarantee protection against loss in a declining market and should not be construed as a promise, guarantee on or a forecast of any minimum returns.

Lump sum has the potential to outshine SIP. However one should remember that SIP offers an averaged out return thus generally insulates against worst returns.

SIP does not assure a profit or guarantee protection against loss in a declining market and should not be construed as a promise, guarantee on or a forecast of any minimum returns.

As the numbers above show, SIP works better than lump sum investment in volatile periods. Since no one can predict market movements accurately it is extremely risky to make bets on what time to buy units or sell them.

One brownie point for SIP

From a practical point of view SIP is the preferred route of mutual fund investments as investing through SIP's inculcates the discipline of saving & investing. It is best to align the frequency of investments with that of earning income. If you are salaried employee, you could go for monthly SIP to regularize your savings. Most of our bills have a monthly cycle so viewing SIP as a monthly 'expense' helps in the investing habit formation.

So what should it be? Lump sum or SIP?

In our view, as stated above, SIP helps you inculcate the habit of investing, and as salaries come in monthly so should investments be. However do not rule lump sum investing out, in case you get your annual bonus or an inheritance it is best to invest that money wisely in a suitable mutual fund. Thus to conclude, for investing in mutual funds we believe one could opt for SIP mode, unless you have a lump sum amount to invest for long term (more than 5 - 7 yrs). However we strongly suggest you to consult with your financial advisor before proceeding with any investment decision.

Above article is authored by Quantum.

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