Imagine two cricket teams playing a one-day international match.
One team has batsmen who prefer to accumulate runs in singles and twos. The other tries to score the maximum as quickly as possible. The accumulators’ approach is less risky, and they will often end up with a reasonably good total, even on a bad pitch. The attackers’ strategy is highly risky. On a good wicket, they may comfortably outscore the opponents. But, on a bad day, they may collapse and lose the plot.
In investing terms, the first team’s approach is like a SIP (Systematic Investment Plan), while the second team’s strategy is akin to a lumpsum investment.
SIP involves regularly investing small amounts of money in a disciplined way. In a lump-sum investment, you will put all your money in one go at the start of your investment cycle.
So, which approach do you choose when you wish to invest in Equity-Linked Saving Schemes – SIP or lump-sum?
Risk appetite: The fundamental difference between the two approaches is the varying degree of risk. SIP offers greater capital protection because you are investing only a fraction of your total investment. For example, if you wish to invest Rs. 1.5 lakh a year in an ELSS to maximise 80C income tax benefits, you need to invest only Rs. 12,500 a month, thus spreading your risk in volatile markets. In a lump-sum, you expose your entire investment. We recommend lump-sum investing only if you’re a seasoned investor. A SIP is ideal if you’re a first-time investor; it helps you begin the habit of investing. When you invest a large amount, your timing must be right. While you don’t need to time markets for starting SIPs.
Returns on investments: While lump-sum investments carry greater risk, they also offer the potential of higher returns in favourable markets. In unfavourable markets losses are comparatively lower when you invest through SIP. In a rising market, the average cost of purchase of a lump-sum investment will be lower than that of a SIP. The opposite happens in a bearish (falling) market.
For example, assume two friends Amit and Sheila decide to invest Rs. 1.5 lakh a year in a tax-saving mutual fund. Amit invests the entire amount as a lump-sum, Sheila opts for the SIP route of Rs. 12,500 per month. When they first invest, the scheme’s NAV is Rs. 10.
So, Amit receives 15,000 units of the ELSS (150,000/10), while Sheila receives 1250 units (12500/10).
Now assume the markets rise steadily throughout the year. Sheila receives units every month at progressively higher NAV. At the end of the year, her average purchase price will be higher than that of Amit, who got all his units at the NAV of Rs. 10.
However, Sheila can get more units at lower NAV in that same year, if markets are in a downward movement. Making SIP more favourable in terms of future profits.
Of course, markets don’t move unidirectionally for long periods of time and are characterised by volatility. In volatile markets, SIPs are a better choice, as you receive more units at lower prices and fewer units when prices are high, bringing down your average cost. This also known as Rupee Cost Averaging.
Cash flow: How much cash you have on hand is an important factor in choosing how to invest. If you are salaried, you may prefer the SIP route. But if you have received a windfall -- from the sale of a property, for example -- you may want to consider a lump-sum investment especially if the markets are favourable.
Lock-in: ELSS or tax-saving funds come with a three-year lock-in. With a lump-sum, your investment gets unlocked in one go after three years from the date of purchase. For example, if you invest Rs. 1.5 lakh in an ELSS on March 31, 2019, the entire investment will mature on March 31, 2022. You can sell all your units or hold on. But, in a SIP, your investments will mature one by one, every month, starting March 31, 2022. All your investments will be unlocked only by March 31, 2023.
Last words: Choosing ELSS helps you maximise 80C tax benefits. Choosing a lump-sum makes sense if you’re approaching the end of a financial year. But starting a new financial year, we would recommend the SIP route, especially if you are salaried and risk-averse.
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