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Lump Sum Investment in Mutual Fund: Meaning, Benefits and Factors To Consider

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What Is A Lump Sum Investment?

The term ‘lump sum’ primarily means a large sum of money. In financial terms, it regards the investment of a substantial sum of money at a single go instead of breaking it down into multiple instalments.

Lump sum investment involves investing all the money currently available to you as an investor. For example, if you desire to invest the entire amount present with you in mutual funds or similar investment instruments, it will be termed a lump sum investment. Lump sum payments are similar but in terms of payment. It does not involve any instalments or breakage of the whole amount.

There are mainly two modes of making investments - Lump sum and Systematic Investment Plan (SIP). SIP includes investing a fixed amount of money on a periodic basis, unlike lump sum investment, which involves only a one-time investment. We will discuss SIPs in more detail in the upcoming chapter. 

Benefits of Lump Sum Investment

  • Large Investment

This route enables investors to invest a bulk amount. If the market shows a bullish movement, the investment value rises exponentially. Lumpsum investments are more convenient than SIPs because, in lump sum investments, you invest once and watch your investment grow. But in the SIP case, you are required to make periodic payments. In addition to it, SIP also creates a psychological cycle of repeated checking for profits. However, you can sit back after investing in a lump sum.

  • Convenient

A lump-sum mode is an ideal option for investors with relatively large amounts of money. Thus, you do not have to make small investments on pre-determined dates. 

  • Potential for Higher Returns

If you have to invest for the long term, you need to follow the market movements closely. You can make a lump sum investment when the market is low but has shown growth potential. Under this scenario, you can earn higher returns via the lump-sum route. 

 

  • No Investment Commitments

 

If you choose to lumpsum mode of investments, you are not required to put future investment commitments. It is often preferable for self-employed people with less surplus income flows.

 

  • Better Control over Investments

 

When you wish to make a lump sum investment in mutual funds, you can control the timing of your investments. You can choose to invest when the markets are at lower valuations. It will allow you to make the most of market corrections.

 

  • Utilising the Windfall Gains in Better Manner

 

You may receive windfall receipts during the year, e.g., leave encashment, incentives, annual bonuses, arrears, etc. You can utilise the windfall receipts better if you decide to make a lump sum investment instead of a SIP. In the case of SIP, the investible amounts are invested over a period, and thus, the balance amounts may continue to stay in savings bank accounts. Thus, the opportunity cost for the amount lying idle in your bank account increases, as it could have been put to better use to generate potentially higher returns than a bank account. 

 

  • Beneficial in Bull Markets

 

Investing in a lump sum might be helpful to you, especially during bull markets. This is because it allows you to make the most of market rallies, as the entire investible amount stays invested during the entire period. This contrasts with SIP investing, wherein the investment is made over time. As such, only a part of the entire surplus can be earned at a given time.

 

  • Power of Compounding

 

As discussed in the earlier chapters, compounding refers to the phenomenon of existing returns on investments earning additional returns for the investors. Albert Einstein once said, “Compounding is the world's eighth wonder.” This highlighted the power of compounding, wherein the returns increase exponentially as the holding period increases. Time is the most significant catalyst for the compounding of returns. However, with SIP investments, the average holding period of investments is lower than lumpsum investing in mutual funds. As such, lumpsum investing helps investors avail themselves of the benefits of compounding better.

 

  • Minimum Charges

 

Lump sum investments are made for one time; thus, they incur minimum charges compared to SIPs, which are periodic investments. Lumpsums have lower transaction costs as well as lower maintenance costs. Hence, you can experience the benefit of investing a large amount in one go.

Factors To Consider for Lump Sum Investments

As discussed, lump sum investments take large amounts at once; hence, investors might find it challenging to let go of the amount at once. However, it becomes easier if you have considered certain factors beforehand like:

 

  • Patience

 

Persistence and Patience are the keys to handling any situation. This is what significantly distinguishes the investors from the traditional traders. Investing and waiting for money to grow over time requires persistence and patience. The temptation to exit from the scheme is relatively high, but only persistence and patience will help you overcome the market condition's downtrend.

 

  • Market Valuation

 

Attaining a perfect market valuation is arduous, yet you can get hold of the same if you look closely into records. Before investing a lump sum, you can look for valuation ratios like the P/E ratio of various market indices. A closer look at the recent three to four quarters can give you an idea of the existing market scenario.

 

  • Expected Returns

 

Like any other mode of investment, the prime aim of lump sum investment is to earn returns. Hence, assessing the returns beforehand is vital to get an overview of the scheme you opt for. Knowing the features of your investment plans and understanding the relevant returns your scheme can generate is essential.

How Do You Calculate Your Lump Sum Amount?

As you might have understood in the chapter on the time value of money, you can arrive at the present value of an investment by discounting its future value, i.e.,

PV = FV / (1 + R)

Where:

PV = Present value of investment 

FV = Future Value of investment 

R = Discounting rate or rate of return on investment 

T = Time period of investment 

Therefore, your lump sum amount to be invested can be calculated by 

  • Entering the future value of your investment, you need to achieve that goal
  • Entering a rate of return you expect on your investment amount over the time period of your investment 
  • Entering the time period  

However, this requires manual mathematical calculation. But you don’t need to worry now. There are a lot of lump sum calculators available on the internet that will help you calculate the lump sum investment amount and the future value of your investment. You must add the above-mentioned inputs, and the calculator will automatically calculate the required output. It will save a lot of your time and effort and avoid the hassle of manual calculation. 

The lump sum calculator can help you make informed investment decisions by providing an estimate of the returns. You can also use the calculator to compare the returns various mutual fund schemes offer before making an investment decision.

Let’s understand better with an example, 

Mr ABC wants to buy a car after five years, costing him ₹10 lakh. He wishes to calculate the lump sum investment amount he needs to make today to accumulate that investment amount needed to achieve the goal. He is willing to invest in a large-cap fund and expects an annual return of 12%. When he enters the relevant details in any of the lump sum calculators available online, he can get an answer to the investment amount required. Mr ABC would need ₹4,52,349 to buy a car worth ₹10 lakh after five years. 

Benefits of Using a Lumpsum Return Calculator

  • This calculator helps you provide the estimated returns for the entire investment period. Using this calculator, you may calculate your investment returns over 1-year, 3-year, and 5-year.
  • It’s very convenient and straightforward to use. Even a layman can use this calculator with ease.
  • It provides you with a reasonably accurate estimate. It is important to note that mutual fund investments are subject to market risks. Thus, it cannot be predicted with 100% accuracy. 
  • It enables an investor to plan finances better based on the return estimate likely to receive at the end of an investment period.

Drawbacks of Lump Sum Investments

Although lump sum investments have their advantages, drawbacks are also associated with them. Let’s discuss them one by one:

  • Irregular Investment: The lump sum investment plan does not inculcate investment discipline, unlike SIP, which involves periodic payments.  It also ignores and does not take care of the regular savings that you might have. 
  • Not Suitable for the Short Term: Markets can be volatile in the short term. Therefore, If you require funds in the near future, then a lump sum mode may not be an ideal solution as the returns are usually derived over the longer term. In the short term, the principal value of the amount invested could be negative if markets have fallen after you have put in money. 
  • Higher Risk: As the investment amount is invested in a single go, the investor might buy fewer units if the market is at its peak. If the markets fall after you have invested, you will incur a capital loss on your amount invested. Also, if the market remains below the peak level where you have invested, there could be a prolonged period of negative returns and the opportunity cost of capital invested.
  • Timing Risk: Market timing is crucial when it comes to lumpsum investments. If you invest when the market is high, the return on investment may be lower. In the opposite scenario, if you invest when the market is low, the return on investment may be higher.
  • No Cost Averaging: When you invest money staggered, you tend to accumulate units of a fund at average prices, as you tend to invest irrespective of the market movements. Thus, you tend to average the unit price, which was at the peak and bottom. This is referred to as cost averaging and is enjoyed by the investors following an SIP route. However, unlike SIP investment, lumpsum does not offer rupee cost averaging. This means that you may not be able to gain from averaging out the market volatility.
  • Lack of Diversification: By investing a lump sum, you risk having a large portion of your portfolio invested in a single fund, which can be detrimental if that fund performs poorly.

Thus, lump sum investments have their own set of advantages and disadvantages. SIPs overcome some of the drawbacks associated with lump sum investments. We will discuss SIP in the next chapter. 

How Can You Choose a Fund for Lump Sum Investments?

Let's say you want to invest some amount in mutual funds but are not ready to take a high risk. If you're looking for a low-risk fund, instead of looking out for a particular mutual fund scheme, it is essential to zero down on the correct category or the type of mutual fund.

As discussed in the mutual fund classifications chapter, several categories are meant to suit the various needs of investors. 

If you're looking at investing for a shorter time horizon and require this money within the next five years, debt funds should be an ideal choice. There are several options available to you in the debt-fund space. For instance, If you have a horizon of at least one to one-and-half years, you can go for a high-quality short-duration fund. As discussed earlier, these funds invest in short-term bonds and are a suitable investment avenue for your short-term goals. But do remember, while debt funds are low risk compared to equity funds, they still carry a bit of risk. 

However, If you're not likely to need this money for the next five to seven years, consider investing in equity-oriented funds. For instance, you can choose an aggressive hybrid fund if you're new to investing, have not invested in equities before or simply want to limit the risk. These hybrid funds invest about 65% - 80% of the portfolio in equities and the rest in fixed income. Thus, an allocation towards fixed income cushions the downfall during a market crash. And since the fund continues to invest most of the portfolio in equities, it generates reasonable inflation-adjusted returns for your long-term goals. The advantage of such funds is that they are much less risky and more stable than a pure equity fund. They gain well when the markets increase but fall less sharply than pure equity funds when they crumble.

If your risk appetite is higher, you can choose a 100% equity-oriented fund depending on your needs and preferences. But please note that whenever you invest in any equity-oriented fund, only dump some money at once. Try to spread your investments across periods. The usual thumb rule is to spread it over half the period you took to earn it. Say, If it's your annual bonus, then spread it over six months.

Once you finalise the right category, look for a fund within it. In the case of a debt fund, the objective is not to achieve higher returns but to look for a high-quality portfolio. Likewise, while choosing an equity fund, compare its performance across different market phases compared to its peers. Don't fall victim to attractive short-term returns. 

How To Invest in Lumpsum Mutual Funds on Angel One?

  1. Open the Angel One app. On the Home page, go to ‘Mutual Funds’.
  2. Choose the Mutual Fund that you want to invest in from the various lists provided on the Mutual Fund portal.
  3. Choose whether you want to invest via ‘ONE TIME’ payment or SIP mode.
  4. Enter the amount that you want to invest.
  5. Click on the payment button to complete the payment and start your investment.

This is about lumpsum investments, and in the next chapter, you will learn about SIPs.

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