Did you just get some bonus, inheritance, or lump sum of cash and find yourself asking what to do with it the best way possible for the markets? You are now in a classic investment quandary: should you invest all of it now, through a lumpsum investment, or should you dollar-cost average it into the market over a period of time, through a Systematic Investment Plan (SIP)?
Deciding is not about whether SIP vs Lumpsum wins out, as it is instead whether your investment philosophy aligns with your financial goals, income stream, and risk tolerance. Understanding the difference between SIP and Lumpsum is an important step in becoming a savvy investor.
Let's look deeper into comparing SIP vs Lumpsum to help you decide how to deploy your money and the right method for you.
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What is a SIP?
A Systematic Investment Plan (SIP) is a method of investing where you invest a fixed amount in a set schedule (i.e., a mutual fund) during a fixed period of time (monthly). It is similar to an automatic recurring payment for your investments.
Key Features of SIP
Discipline: SIP inherently creates financial discipline by making the investment automatic. By committing to putting money aside for savings, you invest through various emotions, and without any intellectual overhead.
Affordability: You can begin an SIP with a minimum amount of ?500, which makes SIP a favourable direction for first-time investors and investors with a regular source of earnings (i.e., salaried).
Rupee Cost Averaging (RCA): This is SIP’s greatest benefit. When the market is high, you purchase fewer units for the fixed amount. When the market is low, you purchase more units. Over a long period of time, the average cost per unit will be reduced by this process, and you will minimize the risk of investing when the market is high and losing money when investing during high markets.
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What is a Lumpsum Investment?
Simply put, a lumpsum investment is an investment of a large amount of capital in one shot (one-time) created by investing in a mutual fund or in a stock. This is if the investor has a large corpus of funds to invest immediately.
Key Features of Lumpsum
Immediate Exposure: Your entire corpus gets exposure to the market immediately as both your capital and your investment start earning.
Higher Return Potential: If you enter the market at a low point (correctly timing the market), a lumpsum investment may ultimately generate a higher absolute return compared to an SIP.
Requires Market Timing: Lumpsum investing relies heavily on when you enter the market. If you enter at a market high, your capital can be tied up for longer periods to recover.
To be successful with a Lumpsum approach, you need to be proficient at either timing or planned market fluctuations. To learn more, read our blog on Fundamental Analysis in the Stock Market.
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Difference Between SIP and Lumpsum Investment
The fundamental difference between SIP and Lumpsum is the level of risk and when you can enter the investment.
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SIP vs Lumpsum - Which is Better?
The right answer to the SIP vs Lumpsum question will depend on two main things: your own financial situation and the current value of the market.
1. When is SIP better?
When you have an income coming in regularly: If you are in salaried employment, it makes all the sense in the world for SIP to be the only option for your investment, as timing your investment into the SIP will match your cash flow perfectly.
When you are an inexperienced investor: If you are new to investing, investing in an SIP will be much less daunting since costs have been averaged over time, and it minimizes the risk of moving all your investment capital in at the wrong time.
When the Market is Volatile or Highly Valued: If the markets are currently at all-time highs or when markets are becoming even more volatile, it is better to SIP because it reduces the rare chance of a sharp market correction.
2. When is Lumpsum Better?
You Have a Chunk of Money Sitting Idle: Let's say you earned a lump sum from a bonus, you sold a property that generated a nice profit, or you inherited a chunk of money. Now, your money is just sitting in your bank account. At that point, a lumpsum investment could be a good option.
The Market is Cheap (A Crash or Correction): If your research and market reports suggest that the market has corrected significantly, making stocks a great buy (at a discount from intrinsic or fair value) compared to the past few months, a lumpsum investment provides a higher likelihood of a better return.
You Have a Higher Risk Tolerance: Investors who are well seasoned in terms of not being overly concerned about short-term sales and volatility and have to strong understanding of market cycles are likely to more frequently choose a lumpsum approach in either a crashing or correcting market.
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The Middle Path: Systematic Transfer Plan (STP)
If you've found out that you have a large sum of cash, but aren't comfortable investing all of it immediately or in one investment, a Systematic Transfer Plan (STP) can be a wonderful compromise.
Invest the entire lump sum into a lower-risk, liquid investment (such as a highly rated, low-risk Mutual Fund).
Set up an automatic periodic transfer (like an SIP) from the debt fund into your target fund or investment (which will be in the equity portion).
That way, your money is not sitting idle, and you are earning money (with the benefit of rupee cost averaging) every time it goes into the equity portion of the investment.
Conclusion
Over time, research shows that how long you are in the market matters more than when you are in the market. For most investors, a Systematic Investment Plan (SIP) is the best option as it enforces discipline, lowers the risk of trying to time the market by using Rupee Cost Averaging, and tapers more to a regular earning style.
But if you are an experienced investor, have a higher risk tolerance, and feel very confident that the market is undervalued, a lump sum investment at the right time can provide better returns.
In the end, the best investment strategy for you is the one you will consistently stick with. Start with what matters to you, establish a disciplined risk profile, and invest in the method that you will ensure you keep contributing, regardless of fearing or being greedy in the market.
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