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SIP Investment vs Lump Sum Investment: Which one is better?

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Mutual fund investing has gained a lot of traction in the past 5 years as can be seen by the burgeoning assets under management of the industry. However, one question continues to challenge both existing and new investors: Between a Systematic Investment Plan (SIP) and lump sum investment, which is better?

The simple answer is: it depends. But before we dig deeper let’s look at the basic principle on which SIPs are based.

The fundamentals of SIPs are rooted in the principle of rupee cost averaging. The facility requires you to invest a particular amount in a chosen mutual fund periodically, typically every month. By investing a fixed amount regularly in a well-managed fund, your money continues to get deployed according to the way the portfolio of the fund is comprised.

Since the investment is made on a pre-set date every period, you do not need to be concerned about the direction of the market movement. When markets are down, you get a higher number of units than when markets are up. In this way, the per-unit cost of holding the fund averages out over a period of time and that is why the principle is known as rupee cost averaging.

Now let’s look at the pros and cons of lump sum and SIP investing.

Assessing lump sum investment

A non-recurring and sizable investment at one go can be advantageous to those who are informed investors and have a broad assessment of the direction in which the market is going. Lump sum investment can outdo SIP investment when the general trend of the market is upwards. Let’s look at an example.

Two investors U and I invest the same amount in the same fund for a 12 month period; the mode, however, is lump sum and SIP respectively. At the beginning of this period, the NAV of the fund is Rs 12 per unit and the intended amount of investment is Rs 1,20,000. Via the lump sum route, U receives 10,000 units of the fund which will remain constant for the period. For I, let’s consider the following table for calculating the number of units:

         
  Month SIP amount NAV Number of units
  1 10,000 12 833.33
  2 10,000 13 769.23
  3 10,000 14 714.29
  4 10,000 15 666.67
  5 10,000 16 625.00
  6 10,000 17 588.24
  7 10,000 18 555.56
  8 10,000 19 526.32
  9 10,000 20 500.00
  10 10,000 21 476.19
  11 10,000 22 454.55
  12 10,000 23 434.78
  Total 120,000   7,144.14

Suppose the NAV at the end of the period is Rs 24 per unit. Then the portfolio value for U would be Rs 2,40,000. Meanwhile, that for I would be Rs 1,71,459 which means that the lump sum strategy outperforms SIP.

This wide gap between the two modes is because while the per unit cost for U stood at Rs 12, that for I stood at Rs 17.5 over the course of 12 months. Due to cheaper per unit cost, U’s holding displayed superior performance in a rising market.

Assessing SIP investment

Let’s consider the same example as above only this time, the NAV is not moving steadily upward; it is up and down.

For U, nothing changes; his per unit NAV cost is Rs 12 and he owns 10,000 units. For I, the following is the updated table:

         
  Month SIP amount NAV Number of units
  1 10,000 12 833.33
  2 10,000 9 1111.11
  3 10,000 11 909.09
  4 10,000 13 769.23
  5 10,000 16 625.00
  6 10,000 14 714.29
  7 10,000 11 909.09
  8 10,000 8 1250.00
  9 10,000 12 833.33
  10 10,000 14 714.29
  11 10,000 12 833.33
  12 10,000 13 769.23
  Total 120,000   10,271.33

The final portfolio value for U at the end-of-period NAV of Rs 15 is Rs 1,50,000 while that for I is Rs 1,54,070.

Even though the average per unit cost for I is slightly higher than U at Rs 12.08, the reason that his SIP strategy outdoes the lump sum strategy is because he has higher number of units than U and the end-of-period NAV is higher than at the beginning of the period.

Which mode to choose?

For lump sum investment to work, an investor needs to have expertise in judging where the market is headed. A rising market would yield favorable results for the strategy, but a falling market would lead to the exact opposite.

For beginners and non-experts, SIP would tend to work better as apart from rupee cost averaging and taking care of a volatile market, it also instills investment discipline and takes away the worry of timing the market.

One thing is for certain, regardless of the path you choose, it is important to remember that patience is required for either mode to create wealth for you. You can refer to the best SIP investments offered by OroWealth and invest your money smartly.

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