For beginners, investing can be a tricky business, with risk management being a crucial part of it. The growth prospects of your investments depend a lot on how you are deploying your money.
Investments can be made in two ways:
1) Investing a sizable chunk at one go, commonly referred to as lump sum. Or,
2) Break down your investments into smaller sizes and allocate them towards investment at periodical intervals. Like every week, month, or quarter, known as the SIP style of investing.
Now, let’s decode both the styles one by one to understand their unique characteristics:
1) Lump Sum Investment
Lump sum or one-time investing implies that investors invest their capital in one shot and top up the investment when necessary.
Advantages of Lump Sum Investing
This method is generally suitable for experienced or high-net-worth investors. They must possess a high-risk tolerance towards market fluctuations.
Lump Sum Investing allows the investors to utilise the market momentum in their favour. This style is generally convenient for individuals who have a large amount to spare for their investments.
The chances of making gains on lump sum investments are high when the market has gone through a volatile period and it is preparing for its way up.
It is also well suited to meet financial goals. Besides, it is an ideal wealth-creating instrument over the long term.
Disadvantages of Lump Sum Investing
Market timing is quite crucial when you invest through the lump sum method. If the investment is done when the market is already at a peak, the risk-reward ratio becomes less attractive. And, market correction can lead to significant ‘portfolio devaluation’ in the short term. What this means is that Investors could end up with fewer units of stock if bought at high levels.
This method is also not ideal if funds are being invested only for a short period. And, it doesn’t cultivate an investment discipline either as the investor doesn’t develop a saving habit or cutting on expenses to accumulate the money for investment.
2) SIP Investing
SIP is a great instrument for small investors who want to invest in smaller quantities at regular intervals. The investment can be made on a weekly, monthly, or yearly basis at predetermined dates. And a sizable corpus can grow over a period of time.
Advantages of SIP
SIPs provide an ideal platform for novice investors as they can start participating in the market with small capital. It is ideal for the salaried class of people as it helps them to develop a habit of regular savings for a long period of time.
Overall, SIPs tend to even out market volatility over a longer period of time with the help of rupee-cost averaging. When the market is up, lesser units are bought at a higher cost. Similarly, investors can buy more units at a lower cost during the downturn.
SIPs are much more flexible instruments as investors can work at their own pace and convenience. Investors can plan investments after considering their current financial resources and other obligations.
Disadvantages of SIP
With SIPs, investors often miss out on good opportunities available in the market, which requires aggressive investment at one go.
Investment is often made at a preset date. Hence, it lacks the flexibility of investing based on the ups and downs in the market. This keeps the investor from taking advantage of the swings in the market.
SIPs are also not ideal for investors who do not have a regular income. The SIPs often end up killing the intent and fail to build up significant wealth if investors stick up with smaller SIPs and fail to increase the SIP amount gradually.
What Suits You the Best?
The stock market is a highly dynamic place. And smart investors are those who can shift gears and make subtle changes to their strategies to gain maximum from the situation at hand.
So, let’s analyse certain scenarios where the investors can use SIP or lumpsum techniques of investment to their advantage.
Mr X makes a lump sum investment of Rs 2,00,000 in a fund at a unit cost of Rs 10. Now, if the market is in an uptrend and the fund’s value starts going up, Mr X stands to benefit from his lump sum investment.
Doing SIP may not be an ideal option here as Mr X would end up buying units at higher levels since their value is going up in an uptrending market. SIP will end up reducing the rate of return in that case.
In the above-mentioned example, we saw how lump sum investing generates better returns for investors in ideal conditions. However, the market is a volatile place that keeps going up and down. SIP helps to navigate this volatility by cutting down on risks.
Let’s say instead of a lump sum, Mr X chose to invest his Rs 2,00,000 via the SIP route. He chose to do a SIP of Rs 10,000 and purchases 1000 units at Rs 10 in the first month. If the market goes down, the same units will be quoted at less than Rs 10 next month. Let’s say the unit value is Rs 8. Here, Mr X would be able to purchase 1,250 units for Rs 10,000 next month.
Evaluating the pros and cons of both methods, it can be concluded that lump sum works best in the rising market. However, SIPs are better for investors in a falling market. From the risk management point of view, it has a high tolerance to volatility. And, investors stand to gain from averaging down the cost when the market falls.
Both these methods demand long-term commitment. Overall, the investors must cultivate the habit of savings and patience to watch their money grow.