SIP vs. Lump Sum: Which is the better way to invest in mutual funds?

Welcome to the world of investment in mutual funds. Mutual funds are certainly a step in the right direction as far as spreading out the risks goes. They help investors diversify their portfolios with different companies and instruments like shares, debentures, bonds, etc. But how do you go about investing in one? Should you look for a Systematic Investment Plan (SIP), or are lump sum investments the way to go?

SIP vs. Lump sum investment: Defining the terms

We look at these two options in detail here, but first things first, let’s clarify all the terms involved.

What is SIP?

This is a mode of investing offered by mutual fund companies. Here, the investor can invest a fixed sum of money in the fund via regular installments. These installments can be weekly, monthly, or yearly.

What is a lump sum investment?

As the name indicates, a lump sum investment is a one-time investment. The investor shells out the money in one chunk. The fund managers respond by allotting a fixed number of shares/units to them.

Both ways of approaching mutual funds come with their advantages and disadvantages. So just weigh the options carefully and choose the one that is best suited to the investor in you.

Comparing SIPs and lump sum investments

As stated earlier, under the SIP, the investor provides a smaller amount of money at regular intervals, which certainly goes easy on the pocket. The investor is also protected against fluctuations in the stock market as his or her investment will procure more units/shares when there is a dip compared to a fixed quantity when the investment is a lump sum. This option also helps in planning savings on a monthly basis, and this payment can be synced with salary dates to ensure there are no slip-ups.
The lump sum option is useful when one has a large amount of money ready for investment, such as a windfall profit, an inheritance, or a substantial bonus. The funds will start generating income from the get-go. However, a word of caution before proceeding: The investor needs to time his or her entrance to ensure that he or she is not buying into the mutual fund when the prices have hit the roof. This is not so much of an issue with SIPs.

Benefits of SIPs vs. lump sum investments

SIPs definitely come with many more benefits than lumpsum investments. To name a few of their pros:

• They are easy on the pocket.
• They can be factored into the monthly domestic budget.
• The ups and downs of the market prices are balanced out.

Factors to consider before investing

As with all other forms of investment, there are risks involved with these two as well. Irrespective of which option you choose, to stay safe, you should ideally ask the following:

How good is the mutual fund company?

While trying to find the answer to this question, they could also focus on the following related questions.

• How long have they been in business? (Though past performance is no indicator of future success, the company’s track record is important nonetheless.)
• Where do they deploy the funds? (Remember, there have been instances where the fund money was diverted to the company’s “other” businesses.)

What is their track record?

To assess their track record, you could look at answering the following questions.

• How regularly has the company been distributing profits?
• In the event of an unexpected emergency, how much is the average time taken to raise a redemption request and payout?
• What are the costs of such redemption?

In addition, one may also do well to look into the three factors discussed below.

1. Amount

The very nature of mutual fund investing makes it possible to plan for comparatively smaller amounts being deployed. SIP is like a recurring deposit where the investor sets aside a fixed monthly sum. With lump sum investments, on the other hand, the investor has to make sure that there is enough money.

2. Market Timing

The maximum returns are obtained when one enters the market at the lowest price possible and exits at the highest. But to pull this off is quite tough. And in the case of a lump sum investment, you must ensure that the timing is right. Not so with SIPs, given their periodic nature.

3. The lock-in period (if applicable)

Some mutual fund schemes stipulate a minimum lock-in period. If investors withdraw money prematurely, they cannot enjoy the associated tax benefits. Investor needs to factor in these variables as well or face the consequences. Ensure that your investment does not hinder any of your short-term commitments.

4. The Flipside of SIP Schemes

Even the best plans may go awry, and investors may be unable to keep up with the payments. Keep this possibility in mind at the time of joining the fund. Most mutual funds do ignore occasional lapses when there are genuine reasons. But it is better to know the penalties attached to default or delay in payments sooner rather than later. Also, make sure you know what the terms for premature closure are.

Conclusion

People usually invest for two reasons:

• Saving for the future, and
• Meeting an unexpected expense—like higher studies or marriage.

The investment amount depends on your savings capacity and how much money you need when the investment matures. It makes sense to open multiple SIPs for varying amounts and periods if there are multiple demands.
So, now that the fog has been cleared regarding the mutual fund scene, happy investing!

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