There are different investment options that you need to study and clearly understand to make a safe investment. One such instrument is mutual funds. Mutual fund investments can be made in two ways: one is as a Systematic Investment Plan (SIP) and the other is as a lump-sum investment.
There has been a long-standing debate about which one of the two is a better investment strategy. In this blog, we will try to find out the answer by comparing both of them using different metrics.
How do SIP and Lumpsum Differ in Investment Outcomes?
Here are some pointers you need to consider.
Timing of Investment
- SIP – here, you need to make the investment periodically, like monthly or quarterly. Every amount you invest gets the benefit of compounding from that period, but due to divided investments, the compounding effect is less powerful.
- Lump sum – in this style of investment, you need to make the investment in one shot. The returns are more predictable in this style of investment because the fixed amount and the full amount get the benefit of compounding from the first day of investment.
Effects of Market Volatility
- SIP – this kind of investment benefits from rupee cost averaging and doesn’t get affected by short-term market fluctuations. Also, units can be bought at a low price at regular intervals.
- Lump Sum – It is highly affected by market fluctuations as you need to invest in one shot and for the short term, which increases the risk of lower returns if the market goes down.
Risk Exposure
- SIP – in this kind of investment, the risk is low as the investment continues for a long time. The risk of the market suddenly going down doesn’t exist because of regular investments over a long period.
- Lump Sum – There is a high risk in this investment regarding sudden market crashes as you are investing all the money in just one shot. A lump sum investment can bring you good returns if the market is bullish, but at the same time, it will bring you severe losses if the market faces a bear run.
Compounding Effect
- SIP – The compounding effect is only applicable to the amount of money you invest regularly, so the compounding effect is divided because of divided investment timings.
- Lump Sum – here the compounding effect is stronger. As you invest all your money at once, the whole amount gets the benefit of compounding over the time it is invested in the market. You can use a lumpsum calculator to understand this.
Predictability of Returns
- SIP -It is tough to predict the returns of an SIP because of the varying interest rates over several years. The returns vary as the amount is invested in different parts at different market levels. You can use a SIP calculator to understand the return better.
- Lump Sum – It is easier to predict the returns of this kind of investment. The whole amount is exposed to compounding effects at once, so it is simpler to predict the returns based on the correct market return rate.
Calculator Methodologies
- SIP – these investment results are predicted based on the several installments you make, the number of years of investment, and the average annual return. It also incorporates rupee cost-averaging.
- Lump Sum – the returns on this investment are predicted based on the current return rate and the amount of money you have invested.
Conclusion
Before choosing between SIP and Lump Sum, you need to understand the compounding effect of both. While the returns on Lump Sum are totally based upon the amount of money you invest at one time, the return of SIP is based on the regular installments and the average yearly return of the market. Both are totally based on two different strategies, and you need to choose the one that suits your financial philosophy.