Last Updated on December 29, 2021 at 6:08 pm
Sudip asks, “Dear Pattu Sir, Thanks to your advice we now have an office-study-group with 12 people discussing money management. One member claimed that over 15 years, a lump sum investment will always beat a SIP. Is this line of thinking correct? Can you please shed some light on this?”
I am delighted to hear you are part of a study group. Be it personal finance or any other subject, this has multiple benefits. See: How you can improve your financial life with an office study group. Of course, different people will have different views, and we should be discerning to stay focused.
Comparing a lump sum investment with a SIP investment is of little use. No one ever is just going to make one investment over 15 years! And the total amount of money invested via lump sum and via SIP will always be different. If you ask the wrong question, you will never find the right answer! Unless you stop and realise the problem.
Sure, I can easily compare SIP vs lump sum investment returns over 15 years in a few minutes. However, even if we do not start a SIP (or equivalently invest manually each month), we will not make one investment and stop for the next 15 years!
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Academics have been compared these two modes for decades to get degrees. They would compare a 12,000 USD lump sum investment with a 100 USD monthly investment over 180 months. Sure it makes numerical sense, but not practical sense. A guy who can invest 12, 000 USD in one stroke would invest a lot more over the next 180 months.
We have discussed how SIP “annualised” returns are computed: What is XIRR: A simple introduction. Whether we invest daily or weekly or monthly or quarterly or occasionally, they are all forms of dollar/rupee cost averaging.
A single lump sum investment’s annualised return can be computed with the standard “compounding” formulae. Although there is no compounding in mutual funds, we do this to compare returns with a risk-free instrument like a fixed deposit to determine if we have got the reward for the extra risk we have taken – aka risk premium.
This compounding formula, aka CAGR, is explained here: CAGR vs IRR: Understanding investment growth measures. For our purposes here, in the case of a SIP, let us appreciate that each investment we make will have its CAGR. When we compute the XIRR, we ask what CAGR I can choose that will be the same for all instalments? This number is the XIRR. The XIRR is an approximation, while the CAGR is exact, although it is a point to point measurement ignoring the journey.
So must appreciate capital market return computation is done in hindsight, ignoring the journey. Forget practicality; even technically, the SIP vs lump sum comparison is on shaky ground because, in SIP, each instalment is done at different market levels. The XIRR is a CAGR “average”. So it is an apple vs orange comparison, however way we look at it.
When people ask, “lump sum or SIP, which is better?” what they mean is, “I have some cash that I wish to invest; should I invest it in one shot or should I invest it little by little (STP) each?”. The answer to that is, “over the long-term, it does not matter!”. See: Investing a lump sum in one-shot vs gradually (STP) in an equity mutual fund (backtest results) Sometimes STP does better and sometimes lump sum. You cannot know how your investment choice will work in future!
This distinction is important because comparing 15-year lump sum returns with 15-year SIP returns is of little use. If you have a lump sum and wish to enter the market “gradually”, you will do it over the next 6-12 months and not over the next 180 months!!
15-year lump sum vs 15-year SIP returns
Let us make this comparison for what it is worth. We shall use Sensex monthly price data from April 1979 to Oct 2021. We need to add about 2% more to the returns to account for dividends, but since this component is missing on both sides of the comparison, it will not change anything.
We shall use this tool to get 15-year SIP, and lump sum returns: Mutual Fund SIP and Lump Sum Rolling Returns Calculators.
There are 327 15-year intervals possible, and the first five and last five data sets are tabulated below as an example. We use the same starting and ending dates for both SIP and lump sum investments.
| From date | To date | 15 lump sum rolling return | 15 SIP rolling return |
| 03-04-1979 | 04-04-1994 | 25.6% | 28.4% |
| 02-05-1979 | 02-05-1994 | 25.3% | 28.1% |
| 02-06-1979 | 01-06-1994 | 25.7% | 28.2% |
| 02-07-1979 | 01-07-1994 | 26.2% | 28.9% |
| 01-08-1979 | 01-08-1994 | 27.2% | 29.1% |
| … | … | … | … |
| … | … | … | … |
| 02-05-2006 | 03-05-2021 | 9.6% | 10.7% |
| 01-06-2006 | 01-06-2021 | 11.5% | 11.4% |
| 03-07-2006 | 01-07-2021 | 11.2% | 11.4% |
| 01-08-2006 | 02-08-2021 | 11.2% | 11.4% |
| 01-09-2006 | 01-09-2021 | 11.1% | 12.2% |
| 03-10-2006 | 01-10-2021 | 10.9% | 12.4% |
Please do not conclude anything from the above! This is just a random sample. Let us look at the full data set.
The following observations can be made:
- Sometimes SIPs wins; sometimes lump sum wins. No one can tell which would win in the future. This observation can be applied to
- lump sum vs STP
- timing the market vs buy-and-hold
- large cap vs mid cap vs small cap
- active fund vs passive fund
- Sensex vs S&P 5000 vs Nasdaq 100 and so on.
- If we can appreciate this one piece of gyan, “nothing will work all the time”, our investing journey would be so much smoother!
- To be precise, lump-sum returns are higher for 173 out of 327 times – 52%. So just about a coin toss between SIP and lump sum.
- What would fare better depends on the endpoint. If the market momentum is high towards the end of the investment journey, a lump sum is likely to succeed. A SIP will fare better if the market falls or moves sideways towards the end of the investment journey. Naturally, there is no way of knowing what the future holds.
- SIP does not reduce investment risk or manage volatility in any way. On the date you choose to calculate returns, your will returns will be up if the market is up. If the market is down, your returns will be down. Myth Busted: SIPs do not reduce risk or enhance returns!
What should investors do? In summary, investors should first stop comparing apples with oranges. SIP or automated investing is the natural way for a salaried investor to choose. If the person gets access to a lump sum from time to time, they can invest it in one shot or spread it over a few months. It makes no difference.
Investing 3-4 times a year on random dates or when the market is down (or up) is also SIP investing over a long duration, like 15 years. There is no magical way to get better returns by deciding the investment date.
“just invest when you get the money with a goal-based asset allocation and don’t waste any time planning strategies or looking at market levels” is a simple mantra we recommend that everyone adopt.
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