LUMPSUM OVER SIPs? WHEN SHOULD YOU CONSIDER THEM?

Are you debating between lumpsum investments and Systematic Investment Plans (SIPs)? Wondering which route aligns better with your financial goals?

Well, you’re not alone.

The dilemma between lumpsum investments and SIPs is a common one among investors. Both approaches offer distinct advantages and suit different financial situations. In this article, we delve into the debate: Lumpsum over SIPs – When Should You Consider Them?

We’ll explore the circumstances in which opting for a lumpsum investment might be more advantageous than sticking with SIPs. From market conditions to personal financial goals, we’ll break down the key considerations that can help you determine the most suitable approach for your investment journey.

So, if you’re grappling with the lumpsum versus SIP dilemma, read on to gain clarity and make confident investment choices.

Table of content

1.What is Lumpsum and When Should You Invest in Them?

• Market Opportunities
• Debt Investments
• Smaller Lumpsum Investments

2.Lumpsum Investment While Switching Funds
3.Conclusion

1.What is Lumpsum and When Should You Invest in Them?

Before we start with why and when you should start investing in Lumpsum instead of SIPs, let’s see what they are.

What is Lumpsum?

What is the lump sum investing method? In lumpsum investing, you invest a large amount of money all at once, typically in a single transaction, rather than spreading it out over time. It’s a one-time investment rather than a regular contribution.

As for when to invest in mutual funds, it depends on various factors, including your financial goals, risk tolerance, market conditions, and investment strategy.

When should you invest via Lumpsum?

Now we shall decode when a lumpsum investment may bear the desired fruits when compared to the much-followed SIP Strategy.

Market Opportunities

If you think the market is undervalued or set for big growth, investing a large amount all at once can help you take advantage of these opportunities right away.

The first such instance is the sudden dips in the markets. The perfect example was the COVID period when the markets plummeted to new lows. That was a very good opportunity for a lumpsum investment. All the stocks or mutual funds that were bought during the lows of March 2020 gave multifold returns and this bull run lasted for over a year.

The second aspect is that of an impending revolution or a sudden upward movement that is bound to happen in a particular sector, and you had spotted it much earlier, does warrant a case for lumpsum investments. In this scenario, investing a lumpsum in the company’s stock or the associated mutual funds can capitalize on the undervaluation and potentially yield significant returns as the market soars. Do note that such a revolution or upward movements do not happen often and may take years to form the base and then rocket.

If the market seems stable and not too volatile, you might want to phase your investments. These are usually called the resting phase where the markets just tend to hover around the same point and the India VIX is a bit stable. Lumpsum investment in such periods may yield good returns as this period forms the base from where it can give us a good CAGR in the longer run.

Debt Investments

To understand why debt investments can be made in lumpsum, we must first understand how a typical SIP works.

In the world of SIP, we aim to invest a fixed amount regularly over some time. This approach helps us benefit from both the highs and lows of the market. After a certain period, like 10 years, we end up with a significant number of units in our mutual funds or stocks. This method allows us to spread out our investments over time, reducing the impact of market fluctuations and potentially building a substantial investment portfolio over the long term. We were able to get a good return as we had averaged or bought more during the downward trajectory of the market.

But when it comes to debt investments, they are resilient when compared to the equity markets as they aren’t much affected by the volatility in the markets. The below tables show the volatility in the debt and equity funds since 2010 based on a 1-month return.

When the decreases in value are not very large, which is often the case with debt funds, the effect of averaging out costs over time is not very significant. Except for when there are losses due to credit events, debt funds generally don’t experience long periods of significant losses.

So, in these cases, by investing and holding onto a fund for the appropriate duration based on its category, you can effectively reduce volatility. If you can consistently follow this approach with discipline, then you may not necessarily need to rely on SIPs for investing in duration-based debt funds.

But this is not the case when you invest in gilt and dynamic bond funds as you might experience a decline in your fund’s returns if the interest rate cycle increases. However, as long as your investment horizon aligns with these funds, these downturns will balance out over time.

Smaller Lumpsum

Imagine getting a big chunk of money from an inheritance, or a bonus and you intend to invest them as lumpsum into the investments where you have already built up some corpus, the lumpsum strategy may be useful for you. However, the effectiveness of this strategy hinges on various factors, with the current state of your investments playing a pivotal role. This takes prominence as we will have to take note of the average NAV/stock price when you invest in lumpsum.

The primary goal of every investment is to get units/stocks at a lower price and benefit from potential appreciation over time. However, investing a significant amount as a lump sum may radically shift the entire portfolio’s price, bringing it closer to the current market price. This phenomenon could undermine the average effect that you’ve diligently cultivated over the years.

Moreover, if a market downturn occurs after making a lump sum investment, your portfolio’s overall value may decrease significantly. This happens because the units or stocks acquired through the lump sum investment would have been purchased at a higher average price, reducing the possibility of future profits leading to a larger period of underperformance.

On the other hand, if the lump sum investment makes up a relatively small portion, like less than 10% of the overall portfolio, its effect on the average price of the units or stocks held might not be as noticeable. This means that the averaging effect obtained from consistent investments over time remains more intact. As a result, the portfolio becomes more resilient to market changes, lowering the chances of substantial decreases in net worth during unfavorable market circumstances.

Do note that the figure of 10% as quoted above is just an ideal number and the exact % of the lumpsum investment depends on your portfolio’s worth.

2.Lumpsum investment while switching funds:

Lump sum investments hold merit, especially when switching funds within the same asset class, be it equity to equity or debt to debt. There are 2 reasons why this is legit.

• First, the key factor influencing returns, volatility, remains consistent regardless of whether it’s the old or new fund, as long as they belong to the same asset class. This consistency guarantees that the risk profile of the investment remains unaltered.
• Compared to methods like SIP and STP, lump sum investments offer distinct advantages in certain situations. While SIPs and STPs aim to average acquisition costs over time, they may not be as beneficial when transferring funds within the same asset class or reallocating from an underperforming to a performing fund. Since both the source and destination funds belong to the same asset class, these methods may not effectively address the goal of reallocating funds within that class. In contrast, lump sum investments provide a direct and efficient means of achieving this objective. By swiftly transferring funds from an underperforming to a promising fund, investors can seize market opportunities without the constraints of averaging strategies. This approach enables prompt reallocation of resources to better-performing assets, potentially enhancing portfolio returns over time.

The same principle applies when considering the opposite scenario. Transitioning from debt to equity may not be advisable unless it’s for portfolio rebalancing purposes. It’s essential to maintain a balanced portfolio aligned with your investment goals and risk tolerance.

Furthermore, there may be situations where shifting from equity to debt becomes necessary as you approach your financial goal. This could be when you need to safeguard the accumulated wealth by transitioning it to a safer investment avenue. In such cases, utilizing a Systematic Transfer Plan (STP) from your equity portfolio to the debt segment can be beneficial. This strategy allows you to maintain exposure to equity while gradually transferring the corpus to debt, maximizing the potential for returns while mitigating risk.

It’s essential to exercise caution when transitioning between asset classes, particularly from debt to equity. Such moves should be driven by strategic portfolio rebalancing needs rather than impulsive decisions influenced by short-term market fluctuations. Investors must carefully assess their risk tolerance, investment objectives, and time horizon before making any significant portfolio changes.

3.Conclusion

In summary, knowing when to use lump sum investments in the market requires careful consideration of various factors, including market conditions, portfolio size, investment goals, risk tolerance, and asset class.

By conducting thorough research, assessing individual financial circumstances, and consulting with financial professionals, investors can make informed decisions that align with their long-term investment objectives and maximize the potential for investment success.

Ultimately, whether to use lump sum investments depends on the unique circumstances and preferences of each investor, and there is no one-size-fits-all approach.

Happy Investing!