‘Which is better? A lump sum investment or a SIP investment?’, is a question I am asked often (comments, emails, questions during investors workshops etc.). Here is why I think such a comparison is meaningless because it originates in a lack of understanding of how a mutual fund SIP (or STP) works.
We recently discussed (circa Feb 2015) this at facebook group, Asan Ideas of Wealth and much of what is stated below is sourced from my comments in that thread.
The “which is better?”, question can and should be dismissed in seconds:
If I have a lump sum now, which I can afford to invest for 10+ years, then the prudent thing to do is to get rid of it as soon as possible (if not instantly, over a duration much lesser than 10Y – a few weeks, or a couple of months at best)
If I don’t have a lump sum now, why am I even asking this question!
To understand why it makes sense to invest the lump sum as quickly as possible, we will need to understand how a SIP works.
Suppose we start a monthly SIP of Rs. 1000 for 10 years. That is 120 installments.
A SIP as we all know averages the point of investment. Sometimes we invest when the NAV is high and sometimes low. ‘Experts’ will tell you that this is better than timing the market.
What those experts fail to point out (for obvious reasons) is that an SIP does not minimize the risk of your entire investment. It only minimizes the risk (by averaging) associated with the next installment.
After one year, the total amount invested is 12 times the next installment in a monthly SIP. The market value associated with 12 x 1000 = 12,000 is exposed to the full volatility of the stock market. There is no averaging here.
Therefore, after one year,
your investment will constitute of a lump sum investment of 12,000 + the next sip installment of 1000
After 5 years,
your investment will constitute of a lump sum investment of 60,000 + the next sip installment of 1000
Get the idea?
Suppose you have 60,000 to invest now, after 5 years, it will have the same level of risk as a Rs. 1000 monthly SIP started at the same time.
There is no benefit in splitting the 60,000 into say, six 10,000 monthly investments via STP. A couple of years later, the entire lump sum will be subject to market risks.
This is the month after month return (XIRR) of a of a SIP in Franklin India Blue Chip Fund from 1st Sep. 1995 to 1st April 2014. A total of 226 installments spread over nearly 19 years! Notice the pretty steep fall in 2008. An SIP will not insulate investors from market crashes.
In Oct 2001, after 6+ years and 74 SIP installments, FIBCF had an XIRR of …..0% Therefore, dont assume SIPs will always work. They will not, in a sideways market – Will SIP or Rupee cost averaging work in a sideways market?
Read more: Tracking a mutual fund SIP: Month by month XIRR (will continuing a SIP for decades decrease folio volatility? There is not enough evidence wrt our markets)
Use this to track your own SIPs: Mutual Fund SIP XIRR Tracker
What is a STP? A STP or a systematic transfer plan is an instrument by which the distributor and the AMC locks your lump sum in their funds. Like the SIP, it is a tool designed for their benefit and not yours! They will tell you that your lump sum will earn higher interest in the few months while the STP runs. This ‘higher interest’ is typically peanuts whether you invest 10K via STP or 10 crores (relatively)
If your duration is long enough, there is no point in a STP. If your duration is short, why are you thinking of investing lump sums in equity funds?
If you wish to invest in debt funds, there is no need for a STP again, you can invest in one-shot.
A STP is a taxation nightmare and is best avoided. Gimmicks like a STP from weekly div. reinvestment arbitrage fund etc. are pointless.
If you are scared of investing in one-shot, let the money lie in your bank SB account for a few weeks. No big deal. Invest once each week, and get rid of it within a few weeks. Beyond that, it is a waste of time.
Not convinced? Here is a study that I did nearly two years ago with Sensex data. We are at present concerned only with the top-right and bottom left panels. For details concerning other graphs, you can refer to the post mentioned below. The horizontal axis refers to various investment durations.
Findings for Lump sum vs. STP
- Both lump sum and STP modes have similar probability of loss irrespective of duration
- The chance of STP doing better than lump sum mode is only 25-35% for all durations.
STP is more a psychological tool.
For more details refer to:
Another school of thought believes in creating a lump sum and waiting for market dips instead of a SIP. The trouble with this approach is that, one may have to wait for months and months for an investment opportunity to show up. The bigger problem is how the opportunity is defined.
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