Personal Finance: How to choose between SIPs and lump sum for better returns from mutual funds?
The stock market is on an upswing right now. This has prompted many investors to look at the market with a lot of anticipation. However, experts maintain that markets will soon enter a correction phase wherein prices of stocks will decline from their current peak to a level that would trend over a long period.
Many investors are unsure of when or how to park money in mutual fund investments as these are market-linked and hence do not promise guaranteed returns. Mutual funds contain investments in both debt and equity. The proportion of these asset allocations decides the risk profile of the fund, thus, allowing people to decide between more risky and less risky investment options.
While the choice of a mutual fund depends mostly on its past performance and the risk appetite of the investor, many are still unsure of whether they should opt for a systematic investment plan (SIP) or make a one-time investment of a lump sum. Both the investment methods have their benefits.
How SIPs work
This method involves a great deal of financial commitment as the predetermined investment amount gets deducted from your savings account every month. Investing through the SIP method is simple. You just have to decide how much you wish to invest every month; it could be as low as ₹1,000 or ₹2,000. The second step is choosing the fund that you wish to invest in. Regular and forced investments will keep you invested in the fund, irrespective of the highs and lows of the market. Depending on the net asset value (NAV) of the fund on the predetermined date, a specified number of units are allotted to your name. During market downturns, when NAV is low, you benefit from more units.
Sahil Arora, director of Paisabazaar.com, a virtual debt syndication services, said, “Market timing of mutual fund investments needs a sound understanding of macro-economic situations, geopolitical trends, policy impact, fundamental analysis, technical analysis, etc. Tracking these may not be an easy task for most retail investors. As SIPs ensure regular and automatic investment, opting for SIP mode will average out the investment cost during market corrections and thereby, save investors from the dilemma of timing their equity fund investments.”
Investing a lump sum
This is like shopping for mutual funds when you have enough money in your hand. If you are inclined to allocate a large portion of your earnings to mutual funds or have benefited from a windfall gain that you would like to divert towards mutual funds, a lump sum investment may be the best option. All you have to do is to choose your fund(s) and decide how much you would like to invest in it.
Archit Gupta, founder and CEO, ClearTax, an online e-Filing website, said, “You may invest a lump sum amount in debt mutual funds rather than equity funds. It is suitable for people looking to attain short-term financial goals. For instance, if you invest for a short time of around two to three years, the safety of the capital is vital, and debt funds are a relatively safe fixed-income investment.”
Most people choose to make lump sum investments in mutual funds when the market and stock valuations are low, ie, reeling under the effect of a bearish market. This is because low NAVs of mutual funds allow them to garner more units that they can later sell when the market is high.
Which one’s better?
Investments in both SIPs and lump sum have their benefits. Contrary to lump sum investors who have to eye the market movement regularly, SIP investors can rest as their investments ride through the market cycle. Harshad Chetanwala, co-founder of MyWealthGrowth.com, a financial and wealth planning company, said, “Stock markets are not meant to move in a straight line, it is this volatility that creates opportunities to invest as well as create wealth over a period.”
To grow wealth with time, investments must be methodical and regular. Adhil Shetty, CEO, BankBazaar, an online marketplace for financial products, said, “Compounding interest yields better results when money is saved over longer durations. If you start a SIP of ₹5,000 every month at the age of 25, at a compound annual growth rate (CAGR) of 12.5%, you will have with you funds worth about ₹1 crore by the time you reach the age of 50. If you stay invested for another 5 years at the same CAGR, your corpus will double to ₹2 crore. However, if you start with the same amount and return rate of interest at the age of 35, your retirement fund will amount to only around ₹26 lakh when you hit 50.”
CAGR helps evaluate returns from investments whose value rise and fall with time. Though this method cannot be used to gauge risk, it can assess how one kind of investment performs against another or against the market index.
If you have the necessary market experience, lump sum investments can help you earn a sizeable corpus over time. You must wait for the market to adopt a bearish attitude during which you can invest a large amount in a lump sum and stay invested for a prolonged period. Tarun Birani Founder and CEO of TBNG Capital Advisors, a SEBI registered investment advisor, said, “If mutual fund investors make a lump sum payment, their job is to then simply periodically review the funds and hold them for a longer time horizon. For example, consider an investor who invested a sum of ₹10 lakh in a certain set of mutual funds expected to grow at a CAGR of 12%. If he remained invested for 10 years, at the end of 10 years he would have built a sizeable corpus of approximately ₹31 lakh. Now compare that with another investor who invested ₹15 lakh with the same growth assumption of 12% compound annual growth rate. However, if he remained invested only for five years, then at the end of that period, he would have built a corpus of only ₹26 lakh even though 50% more amount is being invested. Thus, the power of compounding lies in remaining invested for longer periods and thus leading to sizeable wealth creation.”
The key to earning from the market is to invest when the market is low and sell when the market is high. Investors new to equity schemes can opt for SIP investments as it relieves them of the worry of having to time the market. Lump sum investments suit best those who know how to time the market accurately.
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