When it comes to investing in mutual funds, investors are often stuck between two popular modes – the Systematic Investment Plan (SIP) route and the lumpsum investment route. Both have their own merits and demerits. In this article, let’s analyse the key differences between SIP and lumpsum investments in mutual funds and understand which one is a better option for you.
SIP vs lumpsum
The key difference between an SIP and a one-time investment in mutual funds is the timing of the investment. In a lumpsum investment, the entire amount is invested in the mutual fund scheme in one go. For example, an investor invests Rs 1 lakh in a mutual fund scheme in one transaction.
On the other hand, an SIP allows investors to invest a fixed amount regularly in a mutual fund scheme. For example, an investor signs up for an SIP of Rs 5,000 each month in a fund. This Rs 5,000 will be deducted from the investor’s bank account every month and invested in the chosen mutual fund scheme automatically.
The advantage of SIP is that it allows investors to benefit from rupee-cost averaging. This means the investment amount buys more units when the Net Asset Value (NAV) of the scheme is low and fewer units when the NAV is high. Over the long term, this brings down the average cost of units.
SIP minimises market timing risk
One of the key benefits of SIP is that it eliminates market timing risk for investors. With a lumpsum investment, the entire amount is invested at the prevailing market levels. If an investor enters when the market is at its peak, they may end up buying high.
However, with SIPs, only a small part of the total intended investment is made every month. This averaging out of investments every month over the long term lowers the average cost per unit for investors and hedges market volatility.
For example, if an investor had started an SIP of Rs 10,000 per month in an equity fund in January 2020 after the markets already rallied, the entry NAV would have been high. But the same SIP continued investing smaller amounts every month even as markets corrected later in the year due to the pandemic. This would have brought down the average entry cost significantly.
On the other hand, a Rs 1 lakh lumpsum invested at the start may have ended up purchasing fewer units due to the high entry NAV levels back then. The lumpsum investor would have been exposed to high market timing risk.
However, SIPs also are not a perfect hedge against market corrections either. While rupee-cost averaging helps lower average costs, the returns are still dependent on the long-term market movement.
Disciplined savings with SIPs
Most retail investors are not adept at market timing. It is often seen that when the markets are rising, investors eagerly invest lumpsums to capitalise on the opportunity. However, when corrections occur, the emotional tendency is to stay on the sidelines.
This behaviour fails to realise that corrections also present opportunities to buy quality stocks and funds at relatively cheaper prices. The disciplined nature of SIPs enforces regular investing irrespective of market movements by withdrawing pre-determined amounts each month from the investor’s bank account.
This ensures funds are continuously deployed in equity markets in a staggered manner over time. It inculcates the habit of disciplined investing and savings amongst retail investors who may otherwise lack financial discipline due to behavioural biases.
Conclusion
The choice between SIP vs lumpsum ultimately depends on the goals, risk appetite, and experience level of the investor. However, for most retail investors, SIP emerges as the preferred option to gain exposure to mutual funds, thanks to its features like rupee-cost averaging, disciplined investing, and the power of compounding over the long run.
