Lump Sum or SIPs: Which Is A Better Choice?

I have been investing in debt funds for the last few years as I have been saving money to fund my daughter’s postgraduate degree. However, as she has won a scholarship, I no longer need all the funds I have been saving. I have a surplus of about Rs 10 lakh which I would like to invest in large cap equity funds. Should I invest all this money at once or use SIPs? – Nitin

It is never wise to invest a large sum all at once, especially in the current scenario. On 7 July, the Sensex notched a new record high of 26,100. Since then, the index has corrected but is still trading relatively close to its peak. Furthermore, current valuations are not very attractive. As shown in the chart, the price-earnings ratio of the Sensex is above its long-term average.

You could use systematic transfer plans (STPs) to gradually transfer your investments from debt funds to equity funds. Th is will eff ectively mean that you will be using SIPs to build up your equity exposure. Th is will enable you to benefi t from rupee cost averaging as your average cost per unit will be lower. By investing fi xed amounts in funds at regular intervals, you will eff ectively purchase more units if the price falls and purchase fewer units if the price rises.

SIPs are a safer way to invest in equities as you do not need to guess the future direction of the market. Lump sum investing involves timing the market successfully. If you are lucky enough to invest at the bottom of the market, you may make huge returns from lump sum investments. However, if you invest at the peak, you also stand to lose a lot. As timing the market is very difficult for retail investors, you should stick to SIPs as this investment method will allow you to participate in the upswings of the market but also restrict losses in a falling market.

As shown in the table below, over the long-term, lumpsum investments may result in a higher return. For example, if you had invested Rs 3,00,000 in the Sensex in 1989, your investment would have grown to more than Rs 1,00,00,000 today. On the other hand, if you had invested through SIPs, your investment would have only grown to slightly more than Rs 20,00,000. However, in the long run, there is very little difference between the returns generated by SIPs and by lump sum investments.

Historically, over several years, equity markets do trend upwards. Consequently, you may miss out on some of the gains and compounding if you invest only through SIPs. For example, if you had invested a sum of Rs 3,00,000 in the Sensex 25 years ago, the entire amount would have compounded at 15% as shown in the table. In contrast, if you had used SIPs, only the first few instalments would have received all the compounding benefits. The last few instalments would have been compounded for only a short period of time.

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Nevertheless, lumpsum investments are not risk-free. Th e variation in returns from lumpsum investments is very large as shown in the table and chart below. SIPs are likely to generate better returns than lumpsum investments in falling markets. For example, if you had invested Rs 79,000 in January 2008 (when the Sensex first crossed 20,000) you would have only made a CAGR of 3.25%. In January 2008, the Sensex was trading at expensive valuations as the price earnings ratio of the index was nearly 25x.

You would have been much better off if you had used SIPs and spread the investment of Rs 79,000 into monthly instalments of Rs 1,000 between January 2008 and July 2014. The return generated would have been nearly four times greater. Furthermore, the current value of your investment would have also been greater if you had used SIPs.

The chart suggests that the returns generated from lump sum investments are dependent on market timing and valuations. When valuations are above average, you may be better off using SIPs as the returns from this mode of investment are relatively more uniform than the returns from lump sum investments. SIP returns will not be significantly affected by market timing or valuations.

But SIPs do have a drawback – they generally underperform lump sum investments in rising markets. This is because you will effectively use your monthly instalments to purchase fewer units at higher prices. The chart below illustrates this phenomenon. If you were fortunate enough to identify the bottom of the market accurately in March 2009, your returns from a lumpsum investment of Rs 65,000 would have been spectacular and would have exceeded 20%. During this period, investments made using monthly SIPs of Rs 1,000 would have resulted in a significantly lower current value as shown in the chart.

Your risk appetite and time horizon should influence your choice between SIPs and lump sum investments.

In the current scenario, you may be better off using STPs to gradually transfer your investments from debt to equity funds. Lump sum investments are not advisable as the Sensex is trading above fair value. If you are prepared to invest with a long-term view, then even lumpsum investments will pay off as an uptick in economic growth should lead to healthy growth in the equity markets over the long-term. Over the last 25 years, equities have gone through several gyrations but have still generated positive returns. In 1989, the Sensex was trading below 1,000 but crossed 26,000 last week. However, you should be prepared to tolerate volatility in the short-term if you opt for the lumpsum route.

T Srikanth Bhagavat
Managing Director, Hexagon Capital Advisors,