Lump-sum Vs SIPs

“Sabar ka phal meetha hota hai”

But the real question is does the fruit taste better eaten all at once, or in several bites?

SIPs or Systematic Investment Plans, operate on the principle of rupee cost averaging, meaning it involves investing your capital in equal installments over a period of time. For example, investing Rs 60,000 in Rs 5,000 monthly installments over 12 months. On the other hand, lump-sum investing is an approach where you invest your capital all at once into a strategic asset allocation. One is not an objectively better approach than the other as both have their respective advantages as well as disadvantages, it is ultimately the investor, you, that decides. So let’s make that decision a bit easier to make today by going into the pros and cons of lump-sum investment and SIPs. Let us first take a look at the pros and cons of lump-sum investing-

Pros:

• Potential for Higher Returns: Lump-sum investing tends to generate slightly higher annualized returns in general.

   

• Simplicity and Convenience: One time investment hence no need for regular monitoring. (although frankly speaking most of us, once invested, are so restless it is impossible NOT to regularly monitor our portfolio)

• Reduced transaction costs: A single, large transaction incurs lower overall transaction costs compared to multiple smaller transactions. Lower transaction costs directly mean that more of your money is being invested, contributing to higher potential returns.  

• Immediate Exposure: In a bull market, if the entire capital is invested at once, your investment is exposed to potential market gains right from the start. If the market experiences a period of growth after your investment, you stand to gain more compared to investing in installments over time. In this way, given you have sufficient knowledge to time the market and recognize an ongoing uptrend, you get to take advantage of favorable market conditions potentially gaining you more returns. For example, if you invest Rs 1,00,000 in an index fund and it grows 10% in a year, your investment now grows to 1,10,000. With an SIP, however, only a portion of your capital would benefit from early growth.

   

Cons:

•  Market Timing Risk: A con that extends from the previous pro of immediate market exposure is that if you invest lump-sum at the wrong time, say before a market crash, a major correction or the beginning of a bear market, it can result in suboptimal returns if the market subsequently declines.

•  Requires Large Sum Of Capital: You may not have the appropriate amount of capital needed to invest all at once in order to experience significant returns on said investment.

•  Psychological Pressure: Short term market movements are unpredictable and fairly volatile. As a consequence, it induces immense anxiety and stress within the investor regarding the volatility affecting their large investment. There is a reason people call the buy-and-hold approach simple and not easy, this is because it is not easy at all to just stand back when you begin to see your portfolio in the red. As much as one does not want to admit it, it does take a toll on you.

Now coming to Systematic Investment Plans (SIPS)-

Pros:

• Rupee Cost Averaging: Through SIPs, you consequently buy more units when prices are low and less units when prices are high reducing the average cost over time. Say the unit price or the Net Asset Value (NAV) of a mutual fund is Rs 100 and you choose to invest. Next month, it drops to 80 and you invest the same amount-

Now the average investment = 100 + 80  = 90

  2

Hence SIPs help to reduce the average cost over time.

• Disciplined Saving and Investing: SIPs require you to have a small amount of capital saved each month in order for you to be able to invest it. It directly encourages and instills a disciplined habit of regularly saving as well as investing within you which is a valuable qualitative benefit that you simply can’t just buy.

• Flexibility: It allows you to start investing with smaller amounts, making it more accessible to the majority of investors. On the basis of personal circumstances, you also have the option to pause your SIP temporarily or even stop it for a longer duration.

• Less stress: Investing over a regular interval of time reduces the psychological impact of market volatility on your overall investment as well as you, unlike the case in lump-sum investment.

Cons:

• Potential for Lower Annualized Returns: By investing small amounts of capital at a time, you may miss out on positive returns in a rising market compared to a lump-sum investment.

•  Long-term commitment: It requires ongoing contributions of a consistent amount of capital which may be challenging for some investors to keep up with considering financial instability or large unforeseen expenses.

• Increased Transaction Costs: Frequent transaction costs as a result of regular contributions can lead to higher cumulative transaction costs which may eat into overall returns.

Which one is more suitable for me?

Ideal Time Horizon  

The ideal time horizon for both lump-sum investments as well as SIPs are generally a period of five years minimum for a variety of reasons including minimizing risk, ensuring significant returns on your investment, avoiding short term fluctuations as well as to enjoy the wonders of compounding returns. The rule of thumb is the longer held, the better.

“In the short run, the market is a voting machine, but in the long run, it is a weighing machine.”

 - Benjamin Graham

This quote perfectly encapsulates how in the short term, the markets reflect market sentiments which comprise the collective emotions, opinions and reactions of all participants that are not rooted in anything objective whatsoever. As opposed to this, the underlying asset which is the company itself and it’s performance will eventually reflect in the price of it’s shares in the long term.

The Tax Element

Profit gained from investment in securities such as equities and mutual funds are known as capital gains. They are subject to tax. The taxation on mutual funds depends on the type of fund it is, they are classified as Equity Mutual Funds, Debt Mutual Funds, Hybrid Funds that can either be Equity oriented or Debt oriented. (Holding period on STCG and LTCG for Equity Funds and Hybrid Equity Oriented Funds is less than 12 months and more than 12 months respectively. Holding period on STCG and LTCG for Debt Funds and Hybrid Debt Oriented Funds are less than 36 months and more than 36 months respectively.)

 It also depends upon the holding period, securities bought and sold under a period of 1 year are subject to Short Term Capital Gains (STCG) Tax whereas securities bought and sold above a period of one year are subject to Long Term Capital Gains (LTCG) Tax.

Each contribution in an SIP is considered as a separate investment for tax purposes. Gains from investments held for longer than a period of a year AKA long term gains up to Rs 1,00,000 are tax exempt. Long term gains past that amount are taxed at a flat 10% (with no benefit of indexation) whereas the rest of the investments are taxed as per STCG of 15%.

A lump-sum investment also incurs 10% LTCG on gains made from investments held above a year and 15% STCG on short term gains.

Tools To Use

To invest either lump-sum or through and SIP, you must first register with an Indian broker by completing your KYC. The documents you need for the KYC include ID Proof, PAN Card and Address Proof. All reputed banks and brokers have the option of an SIP. Online brokers such as Zerodha Coin, Upstox, Groww etc tend to have a more approachable platform for beginners with more user-friendly UI. Now you may be asking yourself “What happens to my investment if say one of these brokerages were to shut down tomorrow?’ and it is a really sensible question to ask. The good news is there is nothing to worry about because your savings are held in a demat account that has no dependency with the brokerage platform and, is in actuality, held by depositories like NSDL (National Securities Depository Limited) or CDSL (Central Depository Services Limited). In the case of a broker closing down, you can check your holdings in the fund house through your PAN Card details and have a period of three years to get paid out.

For specific examples to calculate with, there are several lump-sum vs SIP calculators on the internet that you may choose from by just searching up “Lump-sum vs SIP calculator”.

Investing above all else is not a test of intelligence but patience, discipline and resilience. Remember, it is a journey, not a destination.