When it comes to investing, the most frequently asked question is – when is the right time to invest? A domain expert has got a simple answer to this – “Whenever You Have Money!”
Naturally, investment would happen only and only if one has got funds to invest. So, instead of asking, ‘when’ is the right time a valid query is ‘which’ is a right or a better option to invest? While based on the individual risk appetite equity, mutual funds, commodities and bullion (now a day’s even Crypto Currencies) are different options, the moot question remains. Should one go for a lump sum mutual fund investment or choose to spread it over a period of time through a Systematic investment plan (SIP)? Let’s first understand the difference between SIP and a Lump sum Investment.
The primary difference between SIP and lump sum is the frequency of investment in mutual funds. As the name suggests lump sum means – a single large investment done by an investor at one go in any mutual fund scheme. On the other hand, SIP means investing a predetermined sum in a mutual fund scheme on a regular basis or predefined intervals. When we say predefined intervals it can be daily, weekly, monthly, quarterly and even half yearly. While both the ways of investing have their own pros and cons, we must discuss how both the strategies of investing weigh on different parameters.
SIP means Lower investment requirement - Easy on the wallet!
On a basic premise of the amount to be invested, SIP scores over the lump sum. SIP quashes the myth that one needs to have a lot of money to be able to invest in mutual funds and then only to generate returns. Further, only larger money would earn you big money. Rather, historically, it has been proved that wealth creation happens on only a steady basis. In case of SIP one can in fact, start investing with as little as Rs.500 every month and increase this amount with time. This helps a new investor to start with a small amount even at an early stage of career when incomes are lower.
A basic rule of compounding states – the more time you give to investment better is the compounding impact. Simply put, if one starts early (possible with SIP at minimum amount), eventually increasing the amount as their career progresses –wealth creation occurs unaffectedly. One has to keep in mind the new mantra of mutual fund investment.
Earlier the equation was:
Income – Expenditure = Savings.
It then became:
Income – Savings = Expenditure.
But a more promising one is:
Income – Investment = Expenditure.
Just to make it more apt, it should be a regular investment. And regular investment in mutual funds is possible through the SIP route.
SIP Inculcates a habit of regular investing and financial discipline
As investment happens on a periodic basis along with a fixed amount and on a fixed date, SIP encourages a disciplined approach to investing. Investor’s bank account is directly debited by the prescribed amount on the mentioned date. Therefore, one is unable to delay investment during a particular period stating that reason required funds are not available. Categorically, it directly fits into the equation of investing first and accordingly managing your expenses. In a new era where there are ‘n’ number of ways to spend, putting regular investment on priority list eventually results in financial discipline.
SIP helps in Rupee Cost Averaging – Not Possible in Lump sum!
When one invests through SIP, he is investing throughout the different stages of a market cycle. This simply means - when the market (Index or the financial instrument we are investing in is low), one tends to get more units at a lesser cost. It is true that vice versa happens when the market (index or instrument) is at highs. Suppose one invests Rs.5000 per month when mutual fund net asset value (NAV) is Rs.100 he purchases 50 units. And when the NAV is Rs.200 one gets only 25 units. Since it is impossible to time the markets, the best thing is rupee cost averaging. What this does is, it reduces per unit cost of the units purchased, thus averaging out the cost of investment.
One can argue that, if they invest a lump sum when markets are at low – returns would be higher compared to SIP. Having said that, it can only happen if you are able to identify the market cycles. Remember, timing the market is almost an impossible task! One can get lucky once or twice – but not always. So, SIP in a way takes away the pressure of timing the markets. This also helps out in a way as investors need not track the market closely and continuously. To be specific, since lump-sum investments are a bulk commitment, investors need to know when they are entering the market. Lump-sum investments are most beneficial when you invest during a market low. With SIP taking care of the averaging factor, Investors do not have to watch market movements as closely as they would have to for lump sum investments.
SIP - Good for budding investors
We’ve mentioned it above that the more time you give investments, the better compounding impact it has. Thus, starting early is an important factor! SIP is a good way for budding mutual fund investors to start early. It is always better not to test the depth of the river with both your feet – simply not going full on and trusting a single game plan when investing is a good idea. SIP is based on the same premise and hence with a smaller amount and lower risk mutual funds budding investors can start investing. If you have just started your professional career, then starting a SIP is the stepping stone to enter the world of investing. This way, you gain exposure to mutual funds with a nominal amount. Later, you can venture into riskier but potent mutual fund schemes that are in line with your investment needs and financial goal.
Compounding – Where it works better?
Compounding is one factor that gives better returns over a period of time. So, when one invests a lump sum for a longer duration, the compounding effect is expected to be good. Then again, this is beneficial if the lump sum investment is made when markets are trading lower. Another crucial aspect is the timing of the market, which cannot be predictable. Historically, it is seen that mutual fund investors (especially the new ones) tend to invest when markets are marching towards new high. Hence, committing a lump sum amount is not a great idea despite the fact that compounding happens better in lump sum. In short, if one invests a lump sum at a high point (and if one goes wrong in timing it), losses may mount higher and investors run out of patience till the next bull-run occurs. In case of SIP, the interest is also reinvested and as going easy on pocket comes handy. SIP Calculators are available to understand such investing in a better way. However, one must understand – in a very long period (above 10 years), the comparison usually becomes meaningless.
Conclusion: It is seen that SIP is a better route for budding investors so as to get the maximum gain out of their systematic investments. It takes away the pressure of timing the market and the larger risk of losing a huge sum. However, lump sums may be invested with careful professional advice.
Pro Tip: As a beginner in investing a.k.a budding investor, we’d advise for you to go ahead with SIPs. Trust us, they’re our favourites too!