It is stated that investing is simple but not easy. The problem is most of the market participants think exactly opposite. And such conviction is higher especially during the bull phase of equity markets. The kind of equity market we have witnessed in the past one year, most of the new entrants have made significant profits by taking direct exposure to the equity route of investment. No wonder even the investment size of such investors has increased multifold. Apart from that it has been historically seen that market participants commit more funds and amounts when the Benchmark indices are constantly making new high levels. And then eventually it happens that investors commit the highest amount to peak of the markets eventually getting stuck as the markets show reversals. And this is not a new phenomenon. Historically we have seen investors committing lump sum amounts and then getting stuck. Most on the street try to time the market and commit a lump sum amount. However one must understand it is not timing the market that is important, it is the time in the market that is important. With such historical evidence, when Lump sum commitment has resulted in investors getting stuck for a longer period, the systematic investment plan (SIP) is what is advised to the new entrants. SIP in simple words means investing a fixed amount on a regular basis in a particular asset class. For example Mr. X invests Rs 5000 per month (First trading session of every month) for a longer period of time. Going ahead we have tried to answer the question raised by new entrants about if it is good to make a lump sum investment or better to opt for an SIP.
Answering the basics
Over the past two decades in equity markets, we conducted many investor awareness programs. And over the period nothing has changed about the investors queries. When it comes to investing the most frequently asked question two decades back and even today is – when is the right time to invest? Everyone tries to time the market. And any domain expert has got a simple answer to it – Whenever You Have Money! Naturally, investment would happen only and only if one has got funds to invest. So rather than asking, ‘when’ is the right time, a valid query is ‘which’ is a right or a better option to invest? While based on the individual risk appetite equity, mutual funds, commodities and bullion (nowadays even Crypto Currencies) are different options, the moot question remains. Should one go for a lumpsum mutual fund investment or choose to spread it over a period of time through a SIP?
Understanding the difference between SIP and a Lump sum Investment
One primary reason for equity investment in Indian market still having lower penetration is – a lot of jargon is used and layman investors try to stay away from such investment assets. However if explained in a simpler manner the new entrants would also like to invest in equity as an asset class. So first understand what is meant by SIP and Lump sum Investment and basic different between the two. Primary difference between SIP and lumpsum method is the frequency of investment in the asset class. As the name suggests lumpsum means – a single large investment done by an investor at one go in any asset class. And SIP means investing a predetermined sum in an asset class on a regular basis or predefined intervals. When we say predefined intervals it can be daily, weekly, monthly, quarterly and even half yearly. While both the ways of investing have their own pros and cons, we must discuss how both the strategies of investing weigh on different parameters.
SIP mans Lower investment requirement – Easy on the wallet!
When it came to investing, Earlier the equation was
Income – Expenditure = Savings.
It then became
Income – savings = Expenditure.
But a more promising one is
Income – Investment = Expenditure.
Just to make it more apt we would suggest, it should be a regular investment. And regular investment in is possible through the SIP route. On a basic premise of the amount to be invested, SIP scores over the lumpsum.
SIP quashes the myth that one needs to have a lot of money to be able to invest in equity to generate better returns. Apart from that it is considered that, only larger money would earn you big money. Rather historically it has been proved that wealth creation happens on only a steady basis.
In case of SIP one can in fact, start investing with as little as Rs.500 every month and increase this amount with time as the income increases. This helps a new investor to start with a small amount even at an early stage of career when incomes are lower. Here we would like to point out one factor that, in equities one can start investing with smaller amount which is not possible in other physical asset classes like realty and physical gold.
So in case of equity one can start small and need not wait for longer to arrange for larger sum of funds. Even a basic rule of compounding states – the more time you give to investment better is the compounding impact. Simply put, if one starts early (possible with SIP at minimum amount) eventually increasing the amount as career progresses –wealth creation occurs unaffectedly. One has to keep in mind the new mantra of investment. (We have explained the same in our earlier blog – How to measure returns?)
Following tables clearly indicates how the early start to investment results in larger wealth creation.
|SIP Start Age||30||40||40|
|SIP Stop Age||60||60||60|
|Monthly Investment||Rs. 10,000||Rs. 10,000||Rs. 41,000|
|Total Investment||Rs. 36 Lakh||Rs. 24 Lakh||Rs. 98.40 Lakh|
|Value at Age 60||Rs. 3.15 Crore||Rs. 1.00 Crore||Rs. 3.11 Crore|
|Wealth Creation||8.75 times||4.16 times||3.16 times|
*Note – For illustration purpose. Returns assumed at 12 percent per annum.
The above table clearly indicates considering the similar compounded annual growth rate (CAGR), the longer the holding period higher the returns are. While the monthly investment of investor A and B are the same with similar returns, in A option the wealth creation is better. Further when we consider option C where the investment started at age of 40 and investment amount is also increased, the wealth creation has been slower.
SIP helps in Rupee Cost Averaging – Not Possible in Lump sum!
When one invests through SIP, he is investing throughout the different stages of a market cycle. This simply means – when the market (Index or the financial instrument we are investing in is low), one tends to get more units at a lesser cost. It is true that vice versa happens when the market (index or instrument) is at highs. Suppose one invests Rs 5000 per month when a share is trading at Rs 100 he purchases 50 units. And when the share price is Rs 200 one gets only 25 units. Similarly when the scrip is trading at Rs 50 one would get 100 shares. One must understand that, as it is almost impossible to time the markets, the best thing is rupee cost averaging. What this does is, it reduces per unit cost of the units purchased, thus averaging out the cost of investment.
The above chart shows how if someone had invested Rs 5000 in Tata Steel shares at the start of every month (first trading session of a month) since January 2011 would have got the number of shares. There are 120 different prices at which the investment is done. Just to put things in perspective, the average buying cost for the person over the ten years would be R 438 accumulating 1489 shares by investing Rs 6 lakh over the period. Similarly if someone would have bought in Lump sum by investing Rs 6 lakh at the start of the period, the number of shares he got would be only 853 shares. If we take the current value of both investments – the SIP value stands at Rs 16.67 lakh and the lump sum stands at Rs 9.56 lakh as of today.
One can argue that, if I invest a lump sum when markets are at low – returns would be higher as compared to SIP. Yes accepted, but it can happen only and only if you are able to identify the market cycles. Remember, timing the market is almost an impossible task. One can get lucky once or twice – but not always. So SIP in a way takes away the pressure of timing the markets. Let’s try to quantify the same again. The lowest price of Tata Steel during the period was Rs 198.30. In that case the number of shares he would have bought would be 3021 shares. But then the possibility of buying at a high is also there. The following table indicates how the investment returns would be.
This indicates that the profit would be higher if the investment was done at the lowest price level. But that time the stock was trading at multi year low and all negative factors surrounding it. In simple words it is not possible to time the investment so precisely and accurately. Even experts can’t do it.
This also helps out in a way as investors need not track the market closely and continuously. To be specific, since lump-sum investments are a bulk commitment, investors need to know when they are entering the market. Lump-sum investments are most beneficial when you invest during a market low. With SIP taking care of the averaging factor, Investors do not have to watch market movements as closely as they would have to for lumpsum investments. Again for those who cannot constantly keep a watch on markets SIP is a better investment tool. Rather those new entrants should build a corpus by opting for SIP. Then as the financial independence is achieved can increase exposure to the equity markets. There are other advantages as well.
SIP Inculcates habit of regular investing and financial discipline
As investment happens on a periodic basis along with a fixed amount and on a fixed date, SIP encourages a disciplined approach to investing. In case of SIP most of the Investor’s bank account is directly debited by the prescribed amount on the mentioned date. Therefore, one is unable to delay investment during a particular period stating that reason required funds are not available. Further even if the person over analyses or becomes conservative, the investment has to pass through. Categorically, it directly fits into the equation of investing first and accordingly managing your expenses. In a new era where there are ‘N’ number of ways to spend, the habit of putting regular investment on priority list eventually results in financial discipline. Further in the case of lump sum, even if someone gets it by liquidating assets or in some other way – he may have to wait for the opportunity to enter. As for him, the price to enter investment may not be right. Eventually the investment may be kept idle (or at lower rates in liquid assets). Hence this may result in loss of opportunity for a certain period. And worst is what if the analysis goes wrong and the right investment price does not arrive. We have seen such a scenario in the last one year where many waited for correction and indices proved them wrong.
SIP – Good for budding investors
As mentioned earlier, the more time you give to investments the better is the compounding impact. And hence starting early is an important factor. SIP is a good way for budding investors to start early. It is always better not to test the depth of the river with both your feet – simply not going full. SIP is based on the same premise and hence with a smaller amount and lower risk (If possible like mutual funds) budding investors can start investing. If you have just started your professional career, then starting a SIP is the stepping stone to enter the world of investing. This way, you gain exposure to mutual funds with a nominal amount. Later, you can venture into a riskier but potent asset class that is in line with your investment needs and financial goal.
Compounding – Where does it work better?
Compounding is one factor that gives better returns as the time period increases. So when one invests lump sum for a long term the compounding effect is expected to be good. But again this is beneficial if the lumpsum investment is made when markets are trading lower. And timing the market is almost an impossible task. Rather, historically it is seen that mutual fund investors (especially the new ones) tend to invest when markets are marching towards new highs. Hence committing lump sum amounts is not a great idea despite the fact that compounding happens better in lumpsum. Basically if we invest a lump sum at a high point (and if one goes wrong on timing it) losses may mount higher and investors run out of patience till the next bull-run occurs. In case of SIP, the interest is also reinvested and as going easy on pocket comes handy. SIP Calculators are available to understand such investing in a better way. However, one must understand – in a very long period like ten years or more the comparison usually becomes meaningless.
Overall it is seen that SIP is a better route for budding investors as it takes away the pressure of timing the market and is easy on the pocket. However when someone has a lump sum amount (arising from some gains from another asset class or investment), it is better to go ahead with professional advice.