Mutual Fund Mondays - SIP vs Lump Sum Investments

A lot of people find it difficult to decide whether they should invest through SIP’s or lump sums. SIP or the Systematic Investment Plan is an investment vehicle offered by mutual funds to investors allowing them to invest small amounts periodically instead of lump sums.’

A person choosing SIP investing can make the payments weekly, monthly or quarterly. A lump sum payment, on the other hand, is simply a single payment of money as opposed to a series of payments. The difference in the modes of payments comes down to the fact that under a SIP investment plan, a fixed amount of money is debited from the bank accounts of the investors and invested in a specified mutual fund.

However, under a lump sum the entire amount is debited at once, as is obvious. A person who decides to invest through a SIP has more flexibility, can stop investing at any time and also increase or decrease the amount of their investments hence, making it easier for retail investors. To increase or decrease the fixed amounts that you pay, an investor is needed to first cancel the existing mandate and then give the revised one. There’s no penalty on stopping SIP’s hence, making it more attractive to the investors.

A person who has investments in a SIP can also add a lump sum amount to the SIP without affecting it. Both SIP and lump sum work better for long-term investors. You can always reap better benefits if you’re in for the long haul. That being said, we can derive that no matter whether it is a SIP or a lump sum mutual fund, both take time to show outperformance. So, if you know you’d need the money in the near future, you might want to consider other sources of investments that are more predictable.

Generally, people prefer SIP’s over lump sum investing. There can be various reasons to that. But to begin with, we can say SIP’s are preferred because they’re more flexible. But to add to that, the most important advantage would be that you don’t need to time the market for a SIP.  We know how markets are volatile and can, therefore, lead to the investor having to make a decision as to when to enter the market in case of a lump sum mutual fund. But a SIP does away with that problem by spreading out the money over various time periods and hence, participate in the ever so changing nature of the markets thus, avoiding severe losses.

If we compare the long-term returns of the both, we find out that it all depends on the availability of cash with you.  Since, in a lump sum mutual fund compounding plays an important role as your money goes out all at once, hence, as the time goes by, the power of compounding increases exponentially.

On the other hand, through a SIP, your money is invested at both the times- market crashes and market highs thus, yielding a weighted average return of your holding period at the end. There’s no best strategy to make an investment in either one of those, but one can always consider a combination of the two to yield the best results. As a novice Investor, we cannot expect every investor to time the market and assume that they would know when is the right time to invest, when is the market booming or falling. An investor who doesn’t panic and make sound investment decisions and has an in depth knowledge of the market can earn a very good return by adopting a combination of the two.

SIP also helps you build the habit of investing as only a small amount is debited from your account every month and it all is invested over time; at the end you will have a lot of savings invested without you knowing. SIPs also help budding investors to start with small amounts while they can test the waters and manage their funds better.

Most people have the tendency to want to withdraw their money from an SIP if the markets have crashed or after a year of negative return which unfortunately, which is only an instinctive decision without proper reasoning to it. Mutual Funds has only added to the market in the past so many years and the industry has only grown since then, hence,  it is safe to say that the markets always enter a corrective phase. You should ideally wait for period of 3-5 years to actually gain an understanding of how the fund is performing. Contrary to the popular belief, it is important and only makes sense that a SIP goes through the corrective period to deliver better results.

Hence, we cannot conclude whether SIP or lump sum delivers better results. Both have their pros and cons. It ultimately is upon the investor and the kind of money available to them to make that decision.