One of the most popular ways to increase one’s wealth over a period of time is by investing in mutual funds. However, one of the key decisions investors face is whether to invest via a Systematic Investment Plan or a Lumpsum investment.
Both methods have their share of merits and demerits, and the right choice is mainly based on the investor’s financial goals, risk tolerance, and investment horizon. Let’s understand the key differences between SIP and lumpsum investing.
Systematic Investment Plan – SIP
An SIP is a way to invest a fixed amount of money periodically in mutual funds; this could be monthly, quarterly, and so on. This option is for those investors only who wish to adopt a disciplined strategy in investment. In such an investment strategy, there is the facilitation for the investment of a small chunk of money periodically over some time rather than one time investment of the whole sum at one go.
Advantages of SIP:
Rupee Cost Averaging: The SIPs help in averaging out the cost of investments since you buy more units when the prices are at low and fewer units when prices are high. It dampens the effect of volatility in the market and cuts down the risk of investing at market peaks.
Discipline and Convenience: SIPs inculcate the habit of regular savings and investment. This is especially helpful for those people who cannot invest a bulk amount of money at once but still want to create wealth over a period of time. SIPs can be automated, making the process hassle-free.
Compounding Benefit: Due to regular investment, SIPs take good care of the compounding facility over time that may grow manifold on your investment in due course.
Reduced Timing Risks: Under SIP investments, you have no headaches about market timings since over a period of time, it averages out the highs and lows. Chances therefore of wrong investment call based on timing are extremely low.
Drawbacks of SIP:
The reality can be that returns may even be lower in bull markets; this is because, especially in a consistently rising market, lumpsum investments work out better since you invested at lower prices initially when the market was low in comparison to SIPs wherein your investments are spread through all types of market fluctuations and changes.
Long-Term Commitment: While SIPs are ideal for long-term investors, they are a bit time-consuming. If you need liquidity or have a short-term investment horizon, SIPs might not be the best choice.
Lumpsum Investment
Lumpsum investment refers to investing a large amount of money at one time, particularly in cases when an investor happens to have a fairly decent amount of capital available at his disposal. Here, the investment is done at one go, and its return depends upon the prevalent market conditions during the period of investment.
Advantages of Lumpsum:
Higher returns are very much possible in bull markets: If the market is on an uptrend, then lumpsum investments can yield higher returns since you are investing a larger sum of money when the prices are low. This gives you the opportunity to capture more growth in a rising market.
No Waiting Period: Unlike SIPs, there is no long-term commitment in the case of a lumpsum investment. Investors who wish to invest once and forget about it may find this approach more convenient.
Drawbacks of Lumpsum:
Timing Risk in the Market: A lump sum investment involves timing the market. If you enter into investment when the market is peaking or overheated, your returns can be badly affected or result in huge losses.
Higher volatility exposure means that the moment a lumpsum investment is made, it is at the complete mercy of the market. This can prove to be very risky as, in volatile or bearish markets, a downturn may result in huge losses.
Large Initial Capital Requirement: This investing requires the investor to have a large amount of capital at one time, which may not be feasible for every investor.
Which one is better for you?
SIP investments, in general, should be ideal for long-term investors. As an investor who wishes to create wealth in due course of time through small steps, SIP as a way of investing offers spreading the risk and gaining from market cycles. For short-term or one-time investors, investing in a lump sum is the best option, assuming that you have adequate capital to invest and when you are confident about the market being at a decent position where it definitely grows.
Risk Appetite: As an investor, if you want a smooth ride in equity investing, then SIP might be the right choice in case you are risk-averse. In case someone can afford the risk with a view to higher possibilities of return, then it may be Lumpsum Investing.
Conclusion
Both SIP and lumpsum have their relative merits. SIP is more suitable for disciplined investors who can stay invested in the long term, reduce risks, and benefit from compounding. Lumpsum, however, can bring in better returns in favorable market conditions but come with the risk of poor timing and greater volatility. The choice between SIP and lump-sum basically depends on your goals for investment, capital at hand, risk tolerance, and view on the future market. Most investors diversify into both to hedge between continuity of investment at regular intervals and the need for higher returns.
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