SIPs outperform a lump sum investment in equities when there is long market downturn followed by a recovery
Lump sum or SIP, is an age-old question in personal finance. SIPs, or systematic investment plans, were originally tailored towards salaried individuals who are able to invest a fixed amount every month.
However, the ‘rupee cost averaging’ benefit of SIPs also made them attractive to those with lump sums; for instance, someone who has sold a property or got a bonus at work.
Staggering your investment through a SIP or a systemic transfer plan (STP) can fetch you better returns than lump sum investments in some situations.
In this piece, we will look at what past data has to say about this subject.
An STP is similar to a SIP since it invests a fixed amount per month in equity markets by redeeming it from a debt mutual fund. Hence, we will consider SIPs and STPs as interchangeable for the purposes of this article.
The short answer is that a SIP outperforms a lump sum investment in equities when there is long market downturn followed by a recovery. An upward trending market or even a short sharp correction followed by a recovery does not suit SIPs.
Let’s take the covid correction. If you invested a lump sum of ₹12,000 on 1 April 2020, a date that was close to the market bottom, you would have ended up with ₹21,798 on 1 April 2021. Staggering the same investment over 12 months in instalments of ₹1,000 would have gotten you just ₹15,900, according to the Morningstar SIP calculator.
The covid correction was simply too short and sharp for a SIP to efficiently capture. The results differ if the correction is prolonged.
Investing a lump sum on 1 December 2007, close to the peak of the 2003-07, bull market would have seen your lump sum of ₹12,000 beaten down to ₹5,542 on 1 December 2008.
A SIP, on the other hand, would have cushioned the fall to ₹7,105. By 1 December 2009, the market had recovered. A two-year SIP of ₹1,000 would have seen your ₹24,000 invested amount grow to ₹30,389 while a lump sum of ₹24,000 would have remained lower at ₹21,285.
Data crunched by QED Capital shows similar results. QED Capital looked at monthly rolling returns for lump sums vs SIPs on the Nifty 50 index. The results show that SIPs outperform lump sums less than one-third of the time. A one-year SIP outperforms a lump sum 27% of the time while a two-year SIP outperforms a lump sum 28% of the time. However, SIPs offer psychological comfort to investors who may be worried about investing during a market peak and this can help anxious investors stay the course for the long term.
Some financial experts prefer hybrid funds to systematic investment plans as a means to control risk.
“I would say, focus on the destination and not the bumps in the journey. For someone with a 10-year time horizon, the market is expected to be higher than the starting point. Hence, a lump sum will nearly always do better than a SIP. If you have a low risk appetite, lower time horizon or concerns on valuations, a lump sum in a hybrid fund is a better way to control risk. SIPs are primarily for those with salaries, not with lump sums to deploy,” said Harshvardhan Roongta, joint chief executive, Roongta Securities, a mutual fund distributor.
However, hybrid funds may not be the best product for an investor who wants a pure equity experience.
“I don’t think hybrid funds are a good substitute for a client who is seeking to be build a pure equity corpus but is afraid of current valuations. A hybrid fund will not give you an equity experience, even several years down the line. It will give you lower returns with lower risk,” said Vishal Dhawan, founder, Plan Ahead Wealth Advisors. “If you consider a five- or 10-year period, the tendency of lump sum to outperform is likely to narrow. So, I would say that from a psychological and practical implementation point of view, go for SIPs or STPs,” said Anish Teli, founder, QED Capital.
QED used IRR to compare SIPs against lump sums in its analysis. But this ignores the impact of interest earned by the bank account or debt fund from which a SIP or STP is done. However, given the short time period and low interest rate environment the effect is marginal.
Statistically speaking, the odds are heavily stacked against a SIP beating a lump sum. However, the psychological and emotional comfort of a staggered approach is very real.
When corrections come, SIPs automatically capitalize on them and take the emotion out of market entry and exit. A smooth and low stress investing journey can outweigh the loss of some extra return. However, that is a choice for each investor to make.