Mutual Fund Industry
| May 15
Vinay, an IT professional, is an amateur investor in mutual funds. He has already studied how mutual funds work and has shortlisted a few schemes, according to his risk profile.
Rohan is also an IT professional, but he is an active investor. He has a diversified portfolio and is currently looking to invest Rs. 50,000 which he has received as a performance bonus from his company.
However, they are not able to decide whether they should opt for SIP (Systematic Investment Plan) or Lump Sum method of investing.
When they sought our advice, we led them through the pros and cons of both methods to help them invest wisely.
In SIPs, the investor regularly invests a small amount of money over a period of time. The investment is made on preset dates and the amount is also predetermined. With regular investment, he can grow a sizeable corpus over a period of time. It can be started with an investment as low as Rs. 500. Hence, it is usually recommended for salaried individuals or investors with low income.
* Investment discipline: Since the investment in SIPs is in the form of weekly, fortnightly, monthly or quarterly instalments, they tend to instill a certain level of investment discipline in the investor in terms of regular savings and investment. For example, you decide to do a monthly SIP of Rs2000 in a hybrid fund. So, on a specified date, let’s say, 7th, 10th or 15th of every month, this amount will be auto-debited from your bank account through ECS or PDCs.
* Mitigates risk: With SIPs, investment is done at regular intervals over a long period of time, therefore it tends to beat the market volatility. Furthermore, when market is up, more units are bought and lesser when it is on a decline. The rupee-cost averaging evens out the volatility.
* Flexibility: Due to the low investment amount and availability of various payment intervals, an investor can time the investment as per his income flow. Further, small amounts of investment do not put pressure on his current financial resources.
* Hassle-free: It is very easy to set up and monitor SIPs. After the initial formalities, the amount will be deducted directly from the bank on the specified date. So, it saves the trouble of manual investment.
* Unsuitable for irregular income flow: This method is not suitable for investors who do not have reliable and regular cash flow as the investment is to be made at predetermined intervals.
* Uniform investment through ups and downs: An investor cannot immediately change the amount being invested in response to the ups and downs in the market. This keeps the investor from taking advantage of the upswings.
* Insufficient funds: If an investor fails to maintain adequate balance in the bank on the day of debit of SIP, the PDC or ECS, as opted, will return dishonoured. This means that the investment will not happen that month.
Lumpsum plans or one-time investing require investors to invest in the fund at one shot. The number of units that can be bought from lumpsum amount on the first day of investment is higher than SIP. This method of investing is usually preferred by aggressive/experienced investors and high net worth individuals.
* Investment of big amount: This is a good option for investing extra cash on hand instead of keeping it idle.
* Convenience: Since the payment has to be made only once, the investor can just relax without worrying about any further payments to be met in the future.
* Ideal for a long term horizon: Lump sum investment is well suited for financial goals like a child’s education & marriage or others which go over 10-12 years into the future.
* Irregular investment: Lump sum plan does not instill investment discipline. It also does not take care of regular savings that an investor might have.
* Not ideal for short term: If the requirement of funds is in the near future, then a lump sum investment may not be the best option as the real returns are derived only over the longer term.
* Higher risk: As the sum is invested at one go, the investor may end up buying lesser units if the market is on a decline. There is no option of buying units in between or regularly. The only option is to invest in a new fund for which an investor may not even have funds due to single cash outflow owing to lump sum payment. So, the market timing is quite crucial while investing through lumpsum method.
The choice of SIP or lumpsum really depends on the investor’s investment goals and risk appetite. There is no right or wrong way. However, an ideal strategy would be the combination of SIP and lumpsum. But, again, this should be done only if the investor has sound knowledge of the market and follows a strict investment discipline.
Now, coming back to our investors Vinay and Rohan, what do you think is the right method for both of them? Well, given Vinay’s investor profile, he should start with SIPs. This will help him to play safe, and give him a fair idea how his mutual investment is growing and whether it is meeting his investment goals over a period of time. In Rohan’s case, since he is already investing actively, he can go for only lumpsum or a mix of SIP and lumpsum.
We hope this clears the dilemma of SIP vs Lumpsum investing!