A Mutual Fund SIP or STP do not minimize investment risk!

‘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.

XIRR-SIP

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.

graph3

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:

Comprehensive Mutual Fund Investment Mode Comparator

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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34 thoughts on “A Mutual Fund SIP or STP do not minimize investment risk!

  1. Advocates of SIP route say that in a SIP you dont time the investment.I dont agree.Even in SIP the timing of investment plays a big role.In a rasing market lump investment is a better option.
    Am I right?

  2. Advocates of SIP route say that in a SIP you dont time the investment.I dont agree.Even in SIP the timing of investment plays a big role.In a rasing market lump investment is a better option.
    Am I right?

  3. yes , you are correct. for me , for stream of income over a period, SIP is a tool for disciplined investment in equity mutual; funds , but for a sizable sum at a time , there is no point to do SIP. OF COURSE EQUITY IS FOR LONG TERM.

  4. yes , you are correct. for me , for stream of income over a period, SIP is a tool for disciplined investment in equity mutual; funds , but for a sizable sum at a time , there is no point to do SIP. OF COURSE EQUITY IS FOR LONG TERM.

  5. Thanks a ton sir.cleared my doubt as I have a lumpsum investment to make.to add to your point I had back tested earlier on the hdfc top 200 fund for two cases.a bull market phase (2003-2007) and a bear market(2008-2013) .

    In Case of a bull market lumpsum investment would trash sip by a huge margin which is a given.

    In case of a lumpsum even made at the peak of bull market (2008) vs sip between 2008-2013, the sip returns beats lumpsum but only by a thin margin.

    Hence as you say the risk is the same through either route but reward ratio is very obviously tilted in favour of a lumpsum investment.

    1. My own experience with an SIP investment in ICICI Exports Mutul Fund:-

      Amount invested thro SIP Rs 10000 pm for 12 Months.To day,s Market Value -Rs 1.72Lakhs
      Had I invested lumpsum of Rs 1.2 Lakhs one year back-To days Market Value-Rs 2.38Lakhs.
      Of course:-
      1.I did not have Rs 1.2Lakhs one year back
      2.I didnt know there would be a big Bull Run one year back.
      My point is even in a SIP mode the timing matters.

    2. In Case of a bull market lumpsum investment would trash sip by a huge margin which is a given.

      I couldn’t really co-relate your above comment. Can you please elaborate more on this?

  6. Thanks a ton sir.cleared my doubt as I have a lumpsum investment to make.to add to your point I had back tested earlier on the hdfc top 200 fund for two cases.a bull market phase (2003-2007) and a bear market(2008-2013) .

    In Case of a bull market lumpsum investment would trash sip by a huge margin which is a given.

    In case of a lumpsum even made at the peak of bull market (2008) vs sip between 2008-2013, the sip returns beats lumpsum but only by a thin margin.

    Hence as you say the risk is the same through either route but reward ratio is very obviously tilted in favour of a lumpsum investment.

    1. My own experience with an SIP investment in ICICI Exports Mutul Fund:-

      Amount invested thro SIP Rs 10000 pm for 12 Months.To day,s Market Value -Rs 1.72Lakhs
      Had I invested lumpsum of Rs 1.2 Lakhs one year back-To days Market Value-Rs 2.38Lakhs.
      Of course:-
      1.I did not have Rs 1.2Lakhs one year back
      2.I didnt know there would be a big Bull Run one year back.
      My point is even in a SIP mode the timing matters.

    2. In Case of a bull market lumpsum investment would trash sip by a huge margin which is a given.

      I couldn’t really co-relate your above comment. Can you please elaborate more on this?

      1. @senthil:I meant that in a period like 2003-2007(typical bull market) lumpsum investment done at any point would far outperform SIP or STP from a liquid fund during the same period.this is obvious.

      2. Such a comparison is incorrect. For a lump sum investment, you calculate CAGR. For a SIP, you calculate XIRR or IRR. Since the method is different, so would the answer. You cannot compare methods in which investment points are different.

  7. It’s counter intuitive but SIP works because all lump sums should be invested right away. And when you are saving from your monthly income, each SIP instalment is in effect your lump sum for that month!

  8. It’s counter intuitive but SIP works because all lump sums should be invested right away. And when you are saving from your monthly income, each SIP instalment is in effect your lump sum for that month!

  9. I find it interesting when salaried people ask this question. Interesting because I wonder how are they generating lumpsum amount from their salary. On probing more they say that instead of SIP, I will invest every month if market falls. And I am like – Oh thats not lumpsum vs SIP .. it is just manual SIP

    1. how u consider when u have that amount in much high digit (lac) still u will go with manual SIP in high bull run 😀

      i m right now getting salary in lac and right now making strong debt (to avoid stress of high bull run!! :D)

        1. It depends on what your goals and whats the investment amount. Say if you earn 1 lakh pm, your goal needs you invest 70k pm then it does not matter you do manual SIP or automated. It is just that automated SIP gives you freedom from checking the market daily and having those missed hearbeats. This is offcourse given that your goals are not anywhere before 10 years.

  10. Most of people suggest that SIP should also be timed. Past study shows when there is bull market its better to go for lump sum & may be in bear market its better with SIP.

    Small question here as far as timing is concern – “How will one know when bull market is going to start, have started or is going to over” ?

    Analysis are done in hindsight so you know that in bull market lump sum is better or in bear market SIP is better. But there is no model which can predict that when will bull market start or when will bear market start.

    As rightly mentioned by Pattu, one can not & should not compare SIP & lump sum. If you do not have money right now…start SIP…if you have money…invest & forget for at least next 10 -12 years.

    Market timing is worthless effort….instead of wasting time in TIMING the market…spend that time in other productive things…let market take care of you instead you trying to take care of market…

  11. This is the most intellegent Artical i have ever read on sip and stp and lump sum etc now it is clear and simple.
    thanks alot

  12. Absolutely true . I have always told in my training equity is long term and lumpsum is better than STP if you have money .SIP is advised more to match the regular income inflow . Also I feel distributor dont want to take risk of losing the client particularly if ticket size is big i.e client is HNI . A 2 lakh and a 2 crore investment if invested and NAV falls by 10% then loss of 20 thousand is less painful than loss of 20 lakh . Also client might say long term but once see a loss his long term conviction changes and so again distributor knowing this not dare to take risk .

  13. I am not sure I got the point as mentioned in this post. Let me raise my query with the following example.
    Assume a MF having nav values for 12 months has follows
    22 18 20 17 16 14 16 18 16 22
    STP investments gets an average nav of 18, while Lumpsum is 22 and STP wins here, in this use case.

    This use case can be extended to long term say We invest lumpsum at 34K Sensex, wihch Crashes to 15K and come back to 34K again after 5 years, but when its averaged out via STP, the earning is better.

    Please correct me, if anything wrong here.

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