Lump sum investors expose their portfolios to the caprices of the market while SIPs reduce the risk of being wrong as an investment is spread out.
Many people ask whether lump sum investment is a better option than systematic investment plan (SIP). I would say both are good options and both have their own advantage. The only relevant question is when to deploy either of these options. Before we dig into the debate about SIP vs lump sum, we need to understand that whether one has enough investible surplus that can be called as lump sum.
One needs to have a substantial lump sum amount to see any meaningful returns. Second point is that just because lump sum is available it does not mean that money should be invested in one go. There can be various other tactics to deploy your funds more efficiently. Both methods work in a different set of circumstances.
Let us say we are in a rising bull market. Investor X invests `4,000 per month for 12 months and investor Y invests `48,000 as lump sum. Investment in mutual funds totals `48,000 for both investors. In the 12 months, if the market appreciates by average 1% every month, then investor Y would have got a total return of `53,760 while for investor X the total return would have been approximately `50,880. The average cost for SIP investors would be higher in the rising market against lump sum investors as they have invested at the lower end of the range.
Now take another example of a falling market. For easy comparison, we will keep the amount same for investors X and Y. If we take that market on average loses 1% every month then losses for investor X (SIP) would be comparatively less than investor Y (lump sum) as cost of purchase would be higher than average cost of purchase in SIP.
Lump sum in rising markets
So when the market is moving up continuously, lump sum investment will give a higher return as the base or cost is lower but in practice, the market never goes up or down continuously. Lump sum is productive when the market is low but it is difficult to calculate the market’s low. One can be wrong about the assessment of low and may enter at the wrong time.
The only drawback of lump sum is that very few people have the guts to again invest if they have additional money and their previous investment is giving a negative return. Suppose investors had invested lump sum in December 2007 when the market was trading at its peak. Investors would have helplessly watched the market fall till March 2009 but if an individual would have invested lump sum at lows during March 2009 then he would have made big gains.
SIP reduces risks
Lump sum investors expose their portfolios to the caprices of the market while SIPs reduces the risk of being wrong as an investment is spread out. For small investors too, SIP is suitable. Smart investors recognise bottoming out of the market and invest in one go but not all are smart investors though one can look at this historical value to gauge how undervalued or overvalued market is.
Just because the market has corrected 1000 points do not assume that it is better to invest a lump sum amount. A better option is to look at the Nifty P/E ratio. Historically, whenever P/E ratio is less than 12, we have seen good returns in three, five and seven years while whenever P/E ratio is above 24, then average 3-year return is in negative while mildly positive in five and seven years.
These are the extreme ranges and we would advise any investor thinking ofmaking a lump sum investment to do it when Nifty P/E ratio is under 12. Currently, Nifty P/E ratio is at 28 so the market clearly is in the overbought zone. So the best option right now would be to start investing through SIP route rather than investing lumpsum at the top end of the range.
(By Dinesh Thakkar. The writer is CMD, Tradebulls Securities)