Wednesday, March 2, 2011

Should you invest in SIPs or lump-sum options?

With the investment habit catching up in India, mutual fund (MF) houses are scrambling hard to take advantage of growing investor interest. Campaigns promoting MF products offer a glimpse of trends that fund houses tend to focus on. The latest addition to this is the increasing focus on systematic investment plans, or SIPs, which offer investors the option to invest a small chunk of their savings in MF units on a regular basis. The SIP option was always available along with the other options of lump-sum investments. 

However, fund houses have raised their sales pitch on the SIP turf in the past few quarters. One reason could be because SIPs tend to offer a more disciplined method of investing for those who have just started looking for avenues beyond fixed deposits of banks. SIPs also expand the reach of MFs to those who cannot afford to invest lump-sums of money at one go. 

But does this mean that SIPs can be viewed as a one-size-fits-all option? What about the fact that a lump-sum investment tends to provide a higher sum on maturity compared with SIPs? But then can one ignore the flexibility SIPs offer to investors when the stock market is choppy? That seems to be enough fodder for confusion. One way to settle this would be analyse the criteria to choose between the two options. ET Intelligence Group helps you to choose between SIPs and lump-sum options that suit your investment needs. There are two investment options for someone who wants to put money in MFs: SIP and lump-sum payments. 


This means investing the entire sum of money at one go. For instance, if you have Rs 1 lakh which you are willing to fully invest in stocks or MFs, it is a lump-sum investment. 


Popularly know as SIP, it is one way of building a corpus steadily. It is similar to a recurring deposit (RD) with the post office or a bank where you stash away a small amount periodically. The investment is spread over a certain time frame. The fund units are allocated according to the prevailing net asset value, or NAV, on that day of the month. You get more number of units if the NAV is low. 


Ideally, the lump-sum option proves to be beneficial when the long-term trend in the economy is positive. On the other hand, SIPs offer a smart option at a time when the markets are sliding since investors can buy more units without increasing the periodic outgo. Further, the risk is lower since only a small portion of savings is invested periodically. However, the stock markets often fluctuate wildly and hence making the choice between the two payment modes can be difficult. One way of sorting this out is to consider the period of investment. 


It may not matter which option you select as long as you are investing in large-cap and multi-cap funds for the long term. This is because SIPs do not necessarily generate better returns than lump-sum investments. Our study shows that returns from both SIP and lump sum are almost the same. This is because, in the long run, time value of money tends to average out the risk. For instance, the monthly SIP return of Reliance Regular Saving Equity , a large-cap fund, over five year is 25% at an annualised rate. 

ts non-SIP annualised return over the same period is 27.5%. But the same is not true for mid-cap and small-cap funds. Since, the rally in mid and small-cap stocks happens in spurts, timing the market becomes critical. While it is difficult to time the market, investors could reduce the risk by opting for SIP. Since a small chunk of the money is invested over a longer duration, the risk is spread evenly across the period. This is not possible in the case of a lump-sum investment wherein the entire investment at once is exposed to market fluctuations. 


For an investment horizon of 1-3 years, the markets tend to be quite volatile. For instance, between January 2008 and December 2010, the Sensex fell by almost 60% only to recover the lost ground in the later half. In such a scenario, investors can use SIP to benefit from volatility in the market, since it allows you to average the cost of fund units. When the markets are rising, you end up buying lower units while in a downturn you will mop up more units. As a result, the average cost of purchase goes down. 

Take an example of HDFC Equity. A monthly SIP of Rs 1,000 started on January 1, 2008, generated annualised returns of 39% as against 10% returns on a lump sum investment of Rs 36,000 made during the same period. However, if one were to compare returns of SIP investments to non-SIP investments from May 2005 to January 2008 - during the period the markets moved up from 6,000 to touch 21,000 -HDFC Equity Fund monthly SIP generated 35% return while non-SIP return (annualised) was 47% over the period. So, SIP makes a better investment option in a falling market. However, in a rising market scenario, SIP may not work well especially in the near term. Does it matter to debt fund investors? 

Untill four years ago, SIP was not a preferred choice in the debt segment, since lower debt market volatility favoured lump-sum investment. However, since 2006, returns in the debt market have become more volatile making SIPs popular. The debt market is expected to remain volatile given rising inflation and monetary tightening. Investors may opt for short-term bond MFs and money-market funds over long bond funds. In the case of short bond funds, SIP is expected to post better returns. 

SIP investors enjoy benefits of cost averaging in a weaker market due to the vary nature of investment. Though such an advantage is not available for lump-sum investors, they can avail of cost averaging through a judicious use of systematic transfer plans (STP). STP is a systematic investment option where an investor can regularly transfer a pre-defined amount of investment from one scheme to another. In the near term, however, the scheme is not expected to generate fancy returns due to weak economic forecasts. In such a scenario, the investor can start a periodic transfer of funds from the existing equity scheme to a debt scheme. The strategy will not only protect returns earned so far but also earn some interest income. 


A smart way to take advantage of market conditions If markets seem to have headed too high and stock-related stories are winning over cricket and movies in public conversations, it's the right to start using the STP route to transfer your investment from equity to debt. When the markets finally show signs of bottoming out, investors can gradually transfer funds back to equity schemes. 


While both SIP and lump-sum options have their merits and demerits, investors should pick one over the other based on their investment needs and strategies. SIP offer the right flexibility to those who find it difficult to make a lump-sum investment. But windfall earnings such as salary bonuses and other monetary perquisites such as signing bonus or gratuity can be invested in lump-sum schemes. 

Those who have a fair amount of clarity regarding their near-term expenses and have adequate savings should prefer the lump-sum route. Remember, though both SIP and lumpsum routes tend to offer the same return over a period, the latter offers a higher maturity sum (see table). While SIPs come with built-in cost averaging shield in times of falling markets, investors opting for lump-sum can take the shelter of STPs to reduce their exposure to the market vagaries. 

Source : ET

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