When investing, you can either go and pick individual stocks to construct your portfolio or you can invest in a Mutual Fund and get exposure to a basked of stocks in one go. The fund is then actively, or sometimes passively, managed by the fund managers and tries to give you the best returns it can. If the fund is doing well, you can keep putting money into increase your exposure to its investments.
Now when investing in a Mutual Fund there are two approaches you can take. If you save only a small percentage of your income, then you might choose to make an SIP investment in a mutual fund, where you invest a certain amount every month on a given date. You can also invest in the mutual fund through a larger lump-sum payment. This can be particularly useful if the market dips momentarily and the fund becomes cheaper to invest in. Both ways of investing in Mutual Funds are valid, but many advise salaried individuals to go for an SIP investment approach. This automates your investments ensuring that you continue to grow your wealth whilst taking some pressure off of you to actively monitor the same. This raised a key question though. Will an SIP investment beat lump sum investments over time? Let’s take a look.
The underlying premise is that no form of investing, be it an SIP investment or lump sum investment, is objectively better, and the returns you get are always contingent on your investing prowess. Having said that, there can be situations where an SIP investment can beat lump sum payments over time, whereas lump sum payments might get the edge in other situations. Lets take a look at two scenarios.
A situation could arise when there is a dip in the price of the mutual fund over time. Assuming that the Mutual Fund rises eventually, an SIP investment would likely net you better returns as you periodically bought the Mutual Fund at a lower and lower valuation. Thus, when it appreciates, you will get higher gains on your investment. With a lump sum payment however, you will not get the advantage of this. You will have have to manually buy more units of the mutual fund, similar to how you would have to do with a stock, in order to take advantage of the dip. You’d also have to try and buy the Mutual Fund at a fairly low valuation in order tot ake advantage of its eventual appreciation.
In another scenario however, if the price of the fund appreciates over the long run rather consistently without any sustained dips etc, then your lump sum investment might gain an edge over the SIP investment method, as you are benefitting from the simple premise of ‘buy low, sell high’. With an SIP investment, you are investing smaller amounts over time, meaning you are buying the stock at routine rises as well, which could diminish returns when compared to a lump sum investment.
As is mentioned before, there is no sure short way to know which form of investment will outperform, as this depends on how well and particularly how consistently the fund you are investing in performs as well as what the size of your investments, lump-sum or SIP are. One must also consider facets such as rupee cost averaging and do due research before you open a demat account to buy a mutual fund through an SIP investment or a lump sum payment.
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