One of the most common doubts that people have while investing in mutual funds is whether to invest through SIP or in the lump sum. Both SIP and lump sum are good choices as each of them have their own advantage and disadvantage. The right question will be when to choose the SIP option and when to make use of the lump sum option. To know the answer to this question, we must first understand what exactly is the amount that can be called a lump sum to invest in mutual funds to get the required results. To see some good returns through lump sum investment option, one must have a substantial amount. Also, just because one has a good amount to be invested a lump sum investment, it is not necessary that all that money has to be invested in one shot. There are a lot of other strategies to invest your funds more resourcefully. You have to understand that each method works in a dissimilar set of circumstances.
The rising and falling market
The risk and the associated gain or loss of returns for SIP and lump sum investments obviously depend on the rise and fall of the market. Now let us consider an example to understand this better. There are two investors, A and B. Investor A invests in SIP for 12 months an amount of Rs. 4000 per month and B invests Rs. 48000 through a lump sum. In both cases, the total amount is the same.
Now let us assume that the market value had a steady rise of 1% each month. At the end of 12 months, investor A will have Rs. 50880 while investor Y will have Rs. 53760. Thus, in a rising market, a lump sum investor will stand to make more returns as compared to a SIP investor.
Now let us assume that the market is falling at a rate of 1% each month. In this scenario, at the end of 12 months investor X will comparatively lose lower amount than investor Y as the cost of purchase of the fund would be higher for Y than the average cost of purchase for X.
Thus, if the market moves up continuously, a lump sum investment will fetch a higher return because the purchase cost is lower. However, in reality, the market never rises or falls continuously. A lump sum investment will fetch more returns only when the market is low during purchase time and then rises continuously. But it is kind of impossible to calculate when the market will be low and one can make a mistake and enter at the wrong time.
On the other hand, SIP investment will reduce the risk of making mistakes as the investments are spread out. SIP is suitable even for a small investor. If you are a nerd with the market and can spend all your time analyzing and watching the market, then you can go for a lump sum investment. SIP is always the best option to start investing in mutual funds to gain good returns and also to reduce your risk exposure.