There is always the question of whether to invest a lump sum or commence a systematic investment plan (SIP). Both these are excellent investment options and are complementary.
Let us understand both the investment strategies in detail before deciding on the better option.
Systematic investment plans
SIPs are fixed investments made at periodic intervals in predetermined products. These may be mutual funds or even direct equities based on individual preferences and financial goals. Your predetermined amount is invested in your chosen investment vehicle on the specified date. The number of units you accumulate is based on the market price of the particular investment product on the specific date. In other words, you are able to purchase more units if the price is less when the market dips. If the market is rising and the price is higher, your predetermined amount is used to acquire a lesser number of units. An SIP is ideal for new investors and people with a regular cash flow.
Here are four benefits of starting an SIP investment.
1. Investment discipline
SIP encourages a disciplined approach to investment. Your bank account is directly debited by the predetermined amount on the specified date. Therefore, you are unable to delay your investment during a particular period stating that you do not have the required funds.
2. Cost averaging
As already mentioned, the number of units purchased on the specific date depends on the market price. Therefore, you are able to average the total cost of your SIP mutual fund investments.
When you invest in a recurring or fixed deposit, you are unable to withdraw the amount before its due date. Furthermore, if you prematurely close the deposit account, you may have to pay a penalty or forego the interest. This kind of inflexibility is not applicable to SIP investments. You may discontinue or partially redeem your holdings in case you need funds to meet any emergency requirements.
Most SIP mutual funds are for a fixed amount invested on the specified date. However, there are some funds that allow you to vary the SIP amount based on the prevailing market conditions. Therefore, if the markets fall, your investment amount automatically increases and vice versa.
Lump sum investing
A lump sum investment means that you invest the entire amount available at once in your chosen financial instrument, which may be direct equity or mutual fund schemes. These are often used by seasoned investors who have experience and knowledge about the financial markets along with having surplus cash.
A lump sum investment is beneficial when the market and shares' valuations are low. Alternatively, it is a wise choice when the price-earnings (P/E) multiple of the market and the specific stocks are low. Here are three benefits of lump sum investing.
1. Control on your investments
When you invest a lump sum, you are able to decide on how much to invest and which financial instrument to purchase. Furthermore, you are able to retain control of your investment because you do not have to rely on the judgment of fund managers. If you have the knowledge and experience, lump sum investment and rolling over the same as per the market conditions may enable to accumulate a significant corpus over a longer period of time.
2. Power of compounding
When comparing SIP vs. lump sum, you must consider the power of compounding. Your investment in an SIP may be as low as INR 500 per month. This ensures you are able to regularly save money over the long term. However, because the monthly installment is small, the actual return may not be very high. On the other hand, when you invest a hefty lump sum and remain invested for a long period, you are able to comprehend the power of compounding. Your capital earns an income either through appreciation or interest. This income when reinvested continues to earn additional returns. As a result, you are able to accumulate significant wealth in the long term.
3. Benefit from market corrections
If you are a well-informed and experienced investor, you may be able to benefit from market corrections. When the market dips, you may invest a lump sum to acquire more units of your chosen financial product. Because you entered at a lower market level, you will be able to make higher returns on your capital investment.
The best strategy includes a combination of SIP as well as lump sum investing. When you invest a lump sum during lower market levels along with periodic SIP investments, you are able to earn higher returns over a period of three to five years. However, you need to be disciplined and must keep yourself well-informed. More importantly, you must not panic in case the market sees a downward trend and start exiting your investments.
Know the basics and start investing today.