Mutual funds are at present the most viable investment opportunity for the majority of investors who are looking to earn great returns. The diversification, tax saving, and simplicity associated with mutual funds gives them the popularity that they enjoy. Now, there are two main ways to invest in mutual funds, namely, through SIP (Systematic Investment Plan) and by annual lump sum payment. Read on to know the differences between these two kinds of mutual funds and understand which one will work better for you.
Understanding the differences between SIP and Lump sum investments
Lump sum investment:
A lump sum investment is something, for which you pay once a year. For instance, say you will have to pay twelve thousand rupees annually. This is a good idea for the ones with a considerable disposable amount with them and a high risk tolerance.
Systematic Investment Plan
Taking the example of those twelve thousand rupees, you can invest the same amount through a sip investment. But, in this case, it will be like investing a thousand rupees each month. This is the perfect choice for the ones who cannot afford to go for a lump sum amount. It also has the rupee averaging advantage over lump sum investment.
So, which one is a better option for your investments?
There is no simple answer to this question because it all depends on the conditions of the stock market. When the trends are showing an upward growth, you are likely to get high returns by opting for lump sum mutual fund investments. On the other hand, if the trends show that the market is falling, investments made through sip plans usually offers higher returns compared to lump sum investments. Let’s look at this through proper examples for better understanding.
● Investments in mutual funds during rising markets
Opt for investing a lump sum amount of twelve lakhs in ICICI Prudential Mutual Fund during the rising market over a period of, suppose 1st October 2014 to 1st September 2014, instead of having a monthly SIP of one lakh in the same fund because the former will bring you higher returns.
● Investments in mutual funds during falling markets
If you decide to invest a lump sum amount of twelve lakhs in Axis Mutual Fund during the falling market over a period of, suppose 1st February 2016 to 1st January 2017, instead of having a monthly SIP of one lakh in the same fund, you will be losing out on profits. The SIP accounts will fare better under these conditions.
Advantages of SIP over lump sum investments
All things said and done, there are some advantages of SIP investments over lump sum investments, such as:
No need to keep a constant watch over the market
The beginners in the world of mutual fund investments are usually unsure about when to enter the market such as to minimize the risks. After all, no one wants to lose out a chunk of their investment because of a market crash. In the same way, they want to make the most of a rising market. SIP makes it possible to spread the money over time and thus, the entire investment never has to face the volatility of the market.
Rupee cost averages
SIP lets an investor invest at various levels of a market cycle. The fund manager purchases more number of units when the market is down only to sell them when the market is at its best. What this does is to aid you in reducing the per-unit costs of buying those units. This is something that the investors know as rupee cost averages.
Developing the habit of making investments
With SIP, you have the option of investing a fixed and manageable amount in a tax-saving scheme. You can start investing with a small amount to develop the habit of making investments.
The right option for the beginners
So, you have just entered the world of mutual fund investments, with not much of a prior experience in the matter. Go for SIP because this gives you access to equities at a minimum amount. As you learn more, you can think of venturing out to riskier but profitable investment schemes.
Going by the past records
If you go by past records, SIP investments are known to have earned better long-term, than is five years and more, returns as opposed to lump sum investment in mutual fund.
Two viable ways to invest in mutual funds
For instance, there’s ten lakh in your account that you want to invest in mutual funds. Until you have a thorough understanding of the market, investing it all in the lump sum investments is not a good idea. So, you can go about it in two ways.
1. You can open a monthly SIP with whatever amount that you feel comfortable with and let the amount in your account be gradually but systematically invested.
2. You can invest it all in one liquid fund and go for a Systematic Transfer Plan from that debt fund to the mutual fund. This settles the debate of sip vs. lump sum and also earns you good returns.
Please note: This article is contributed by Laxman.