When it comes to mutual fund investing, there are two popular options – a systematic investment plan (SIP) and a lumpsum investment. Both have their own advantages and disadvantages. So which one is better – SIP or lumpsum investing? Let’s deep dive into both approaches and see which has an edge.
What are SIP and lumpsum investing techniques?
An SIP allows investors to invest small amounts regularly in a mutual fund scheme. For example, one can invest Rs. 5,000 every month via SIPs. On the other hand, lumpsum investing means investing the entire amount at one go. For example, investing Rs. 60,000 in one go.
The power of compounding
One of the biggest advantages of systematic investment plan over lumpsum is the power of compounding that kicks in when you invest regularly over long periods of time. Compounding means earning returns on your returns. The longer your money stays invested, the bigger the compounding impact. Let’s understand this with an example. Consider investing Rs. 10,000 annually for 25 years via an SIP in a mutual fund investment that delivers 12% returns annually on average. Your total investment would be Rs. 2.5 lakhs (Rs. 10,000 x 25 years). The future value after 25 years would be around Rs. 3.87 crores.
Now consider investing the same Rs. 2.5 lakhs as lumpsum. Even if this earned the same 12% returns annually on average, the future value would be around Rs. 3.11 crores – around Rs. 76 lakhs less than the SIP route. This shows how the power of compounding gives an edge to SIP over lumpsum over the long run.
The risk of timing the market
While lumpsum investing may seem attractive due to investing the full amount at one go, perfectly timing the market to enter at the right time is next to impossible. What if you invest lumpsum and the markets correct soon after? Your returns potential over the investment period would reduce. With an SIP, you average out your purchase cost by investing smaller amounts regularly. This helps reduce market timing risk. Even if the markets correct post your investment, your subsequent SIP installments will purchase more units since NAVs are lower now. This rupee cost averaging feature of SIPs provides a significant benefit over a lumpsum investment.
Inflation impact
Due to the power of compounding and rupee cost averaging working in its favour continuously over long periods, an SIP also provides greater protection against inflation. Let’s understand this with an example:
Consider an SIP of Rs. 10,000 per month for 20 years at 12% returns. The future value would be around Rs. 2.86 crores.
Now consider a lumpsum investment of Rs. 24 lakhs (Rs. 10,000 x 12 x 20 years) at the same 12% returns. The future value would be around Rs. 2.53 crores.
Even if inflation is at just 5% annually, the SIP investor’s returns are well ahead to beat inflation. But the lumpsum investor would struggle due to lower absolute returns despite the same investment period and returns rate. This inflation hedging ability makes an SIP more powerful.
Flexibility of SIPs
An advantage of SIPs over lumpsum is the flexibility they offer. With an SIP, you can stop further investments anytime or even pause them for some time if required without exiting the investment completely. While with lumpsum, the only option is continuing with the investment or redeeming the entire amount if needed before the goal timeframe. This flexibility of SIPs is not available with a lumpsum investment.
Conclusion
For investor goals that are 5 years or longer, SIPs emerge victorious over lumpsum in the Indian mutual fund investment context. Their inherent strengths of rupee cost averaging, power of compounding and flexibility make them a powerful wealth creation tool when practiced religiously over many years.
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