Before understanding why are SIP better than lump sum in mutual fund Investment, let’s have a quick revision of the basic concepts.
What are mutual funds
Mutual funds are a group of organization that pool the money from the investors and collectively invest it in the stock market.
Since investing in equity markets requires some set of financial knowledge, it may not be possible for the investors from the non-financial background to participate in direct equity investment.
Thus, the experts under the mutual funds, help these investors to channelize their investment in the equity markets.
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Every mutual fund have units allotted to it called as NAV (Net Asset Value). Just like how the prices of stocks moves in the market, so does the price of NAV. The price of the NAV is dependent on the underlying stocks in which the mutual fund has invested the money in.
If major stocks under the mutual fund fall, so will the value of NAV and vice versa. Thus, just like stocks, one needs to time the market to enter or exit the mutual fund investment.
Since it is not practically possible to find the highs and lows of equity market, there is no right time in starting any investment
There are two ways by which one can invest in mutual funds.
- Invest by a Systematic Investment Plan (SIP)
- Invest by a lump sum amount
What is SIP investment
Systematic Investment Plan (SIP) is a type of investment plan where an investor can decide to invest in installments. Having an active SIP account forces the investor to set away a defined quantity at regular periods, which helps in developing a financial discipline over time.
These investments are made on a uniform frequency of weekly, monthly or quarterly. Ideally, investors select the monthly cycle in mutual fund investment. The process of SIP is that, every month a set amount of money will get auto deducted from your bank account and the same will get invested in the mutual fund. This set amount of monthly investment can start from as low as Rs. 500/- per month.
What is lump sum investment
Lump sum form of investing is a way by which the investor decides to invest all his capital in a single transaction. Here the investor plans a particular date of investment and channelizes all the money in one go. The minimum amount for lump sum investing can be Rs. 5000/-.
Here are 10 reasons why SIP better Than Lump Sum in Mutual Fund Investment
- Inculcate a habit of investing
- Small entry ticket
- Leverage the power of compounding
- Invest in different time frames of the market
- Plan a goal based investment
- Proper mechanism for planning the investment
- A better approach of investment for salaried employees
- No need to time the market
- Take advantage of rupee cost averaging
- Less stressful compared to lump sum investing
Let us now understand these points in detail.
10 reasons why SIP is better than lump sum for mutual fund investment
Inculcate a habit of investing
Starting an SIP in mutual funds helps an investor to build a habit for future investment. When an investor starts his investment with a small amount, it builds his confidence to invest in the times ahead. Thus, this is a great approach for a beginner to start his investment in equity markets.
Small entry ticket
As the entry ticket in a SIP investment is small, it makes it easy for the investor to start his investment early on in life. Even a student, above 18 years of age can start an SIP of Rs. 500/- per month.
Starting an SIP allows the investor to enter early on in investment and gives a longer time frame to stay invested. Thus, benefiting from the effects of compounding.
Leverage the power of compounding
Compounding is the act of reinvesting an asset’s earnings, whether through capital gains or interest, to create more earnings over time. As the investment will create revenues from both its initial capital and the cumulative earnings from previous periods, this growth is computed using exponential functions.
When the investors invests their money in mutual funds, the investor is not only rewarded with the capital appreciation of the asset, but also the gains accumulated due to the dividends earned. If an investor selects a growth fund, this dividend money will further get re-invested in their mutual fund portfolio.
The advantage of compounding is that the investors can make gains on the returns earned on their base investment. Thus, starting an SIP early provides the investor an access to benefit from these compounding gains.
Invest in different time frames of market
When an investor invests in mutual fund using SIP, he enters the equity market over different times frames of the price movement. As the equity markets tend to fluctuate with time for the short term, the investor may not be aware as to when to enter the markets with lump sum amounts.
Starting an SIP lowers this risk of entry and exit for the investors as the money will be invested in a uniform frequency over a long time frame. Investing in different time frame reduces the risk of the investor when the markets are over valued.
Plan a goal based investment
SIPs can be a great tool for a plan based investment. If an investor has long term plans like retirement or children’s education, he can do so by investing in high risk mutual funds. If the investor has short term goals, he may select low risk mutual funds.
A proper SIP can help the investors meet their goals by investing in small amounts for a creation of accumulated wealth over the desired duration.
Proper mechanism for planning the investment
A SIP provides with an investor a proper mechanism to invest in equity. The returns gained from fixed deposits and bonds may no be sufficient to beat the rising inflation.
Thus, a proper SIP allows the investor to channelize the funds from the back account to the investment fund.
A better approach of investment for salaried employees
It is usually difficult for a salaried investor to participate in lump sum investment. Thus, the most favorable way for such an investor to enter the equity markets is by starting a SIP.
The investor can plan his expense accordingly from his monthly salary and invest the rest in mutual funds by way of SIP. The investor can select the date of receipt of salary as their investment date. Thus, the money will automatically get invested on the desired dates.
No need to time the market
One of the most challenging factor for a lump sum investor is to time the market to enter an investment. No matter how experienced an investor is, one can never rightly time the market. Thus, investing by way of an SIP, eradicates the risk of this wrong timing.
Studies have shown that investing using an SIP has yielded higher returns of about 20%, when invested against a wrong timing of lump sum investment.
SIPs decrease the average cost of investing since they bring you additional units when the market is down. In the long run, this results in better returns.
Furthermore, while investing in mutual funds via SIP, there is no need to be concerned about market volatility.
Take advantage of rupee cost averaging
Rupee cost averaging is a phenomenon that averages the overall value of the NAV of the mutual fund.
Since the investment via an SIP is made in a span of uniform intervals, the average value of the all the investment is used to calculate the the net returns.
As the market move in a irregular pattern, the investor tends to continue staying invest even when the markets are bearish as well as bullish. Thus, averaging the overall value for better comprehensive returns.
Also, the average buy value of investment decreases because the investment is spread out over time. As a result, market volatility has the least impact on mutual fund SIP investments.
Investing via SIP makes it less stressful for the investor in the times of high volatility. This does not create any anxiety among the investors to constantly check the price of the markets and check the portfolio.
If the markets are up, it is advantageous to the investors as his portfolio is in green. On the other hand, if the markets are down, it is again beneficial as the investor will get the mutual fund units at a cheaper price. Thus, making it a win win situation.
Frequently Asked Questions
An SIP can be started with a minimum amount of Rs. 500/-
Mid Cap and Small Cap Mutual Funds are more favorable for a long time investment.
The expense ratio is considered over the accumulated amount annually.
The exit load charges are calculated differently for each frequency of investment amount. If the lock in period is 1 year and the investor has invested via SIP for 2 years, then for the previous year SIPs, no exit load will be chargeable.
Investing via lump sum or by way of a SIP, both equally have their set of advantages and disadvantages.
One needs to understand their investment goal, source of creating funds and reserves and surplus cash before making their investment decision.