SIP or Lumpsum?

Indian equity markets have yielded great returns in the last eighteen months. Nifty50 TRI has generated an absolute return of 117.9% (annualized return of 63.83%) for the period 1st April 2020 to October 31, 2021. Many other indices such as NIFTY Realty TRI or NIFTY Metal TRI have yielded even higher returns.

This sudden rise in a relatively short period of time is making investors quite nervous regarding expected future returns. Investors who have not participated in this rally are getting FOMO. However, at the same time, the possibility of a significant market correction, once they enter at these elevated valuations, is further complicating the investment decisions.

Nobody can deny the possibility of a correction. But who knows how much time will elapse before this correction happens? It is certainly possible that markets witness a significant further rise before facing a 15-20% correction.

Many advisors are solving this conundrum by recommending the Systematic Investment Plan (SIP) route for taking equity exposure. The latest AMFI data suggests Investors are indeed flocking towards SIPs. The number of SIP accounts stands at 4.64cr in October 2021 compared to 1.28cr in March 2017. As of Oct-21, SIP AUM stood at Rs 553,532 cr out of an average equity AUM of Rs 13,12,982cr, giving SIP AUM a share of 42%. Nearly one-third of overall retail AUM is accounted for by SIPs.

Which approach gives more returns? SIP or Lumpsum?

Let’s compare lumpsum and SIP performance over various periods of time. We have considered three time periods: 1 year, 5 years, and 15 years.

We have considered six data points for each period. Three data points correspond to high equity return periods and three pertains to low/negative equity return periods to get a complete picture across market cycles.

The below tables summarize the return performances for lumpsum and SIP approaches:

We can see from the above table that for one year time periods:

• There is huge difference in annualized return % between lumpsum and SIP approaches in one-year periods.

• Lumpsum performed better in rising markets.

• SIP performed better in two out of three periods of falling markets.

• It is important to note that for period ending March 03, 2020, ending corpus was lower in case of SIP even in the falling market. This is because of sudden fall in markets near the end of the period.

• In case of gradual fall in markets SIP is likely to perform better due to averaging down of the purchase price but in case of sudden fall near the end of the period SIP performance may not be better.

• For period ending 14 Dec 2011, annualized return of SIP approach is lower but ending corpus is higher compared to lumpsum. This is due to difference in average holding period between these two approaches. In case of SIP, on completion of one year only the first installment completes one year. As the further investments are made gradually on monthly basis the average holding period for entire corpus is only 6 months vis-à-vis 12 months for lumpsum. Hence comparing CAGR return is not the correct way to compare performance of these two approaches. Better way is to compare ending corpus for each of the case.

We can see from the above table that for five-year time periods:

• Difference in annualized return % between lumpsum and SIP is much lower in five-year period vis-à-vis one year period. However, ending corpus is much lower in SIP vis-à-vis lumpsum in rising markets compared to one-year periods.

• In line with one-year periods, lumpsum performed better in rising markets and SIP performed better in two out of three periods of falling markets.

We can see from the above table that for fifteen-year time periods:

• Difference in annualized return % between lumpsum and SIP approaches is much lower in fifteen-year periods vis-à-vis one-year and five-year periods. However, SIP ending corpus is much lower as a % of lumpsum corpus compared to shorter periods.

• In all fifteen-year periods, lumpsum has yielded better returns, as in all such periods markets have generated positive returns.

We can see from the above data that lumpsum performed significantly better compared to SIP route for longer time periods. Even in short periods of falling markets when SIP performed better the outperformance is only marginal.

• Does it mean SIP is not a better approach vis-à-vis lumpsum?

• Does it mean investors are wrong in choosing SIP over lumpsum?

• Does it mean SIP is only a marketing gimmick or offers some real value to investors?

• Does it mean advisors who are recommending SIP route wrong?

Is there any benefit in choosing SIP?

Despite generating lower returns vis-à-vis lumpsum, SIP has many advantages. Let us understand some of these in detail:

Fund Availability

It may be noted that the main reason for the outperformance of the lumpsum approach vis-à-vis SIP is on account of two reasons.

1. Average holding period for SIP is half of lumpsum. This is due to gradual fund deployment in case of SIP. Lower holding period will result in lower returns.

2. In longer time periods, Indian equity markets has been on an increasing trajectory. Which means, if any investment is made earlier, the average cost will be lower. It means, on average, purchase cost is higher in case of SIP.

So, in Indian markets which has long-term rising trends, any approach which enables investment as early as possible is likely to yield better results. Most of the investors have regular monthly inflow in the form of salary or business income. If the investor accumulates funds in her savings account, for say 12 months, and then deploys the corpus in equities via lumpsum, the corpus will have a lower holding period compared to an SIP route wherein funds are deployed on an immediate basis. Early deployment of funds in the SIP route is also likely to result in lower average purchase cost in markets where long-term trend is on the rise.

What about lumpsum funds received via say bonus, inheritance, ESOPs etc?

Going by past records, the immediate deployment of funds should be a better option in such cases vis-à-vis spreading the investment over a period of time by SIP (or STP). But there are some other primarily psychological factors that make the SIP approach worthwhile even in such scenarios.

Let’s discuss.

Volatility

Returns should not be the only criteria when we evaluate the performance of two alternative investment options. We must consider the volatility also. If we see the NIFTY 50 TRI for a five-year period ending 1 Nov 2021, we can see be that the lumpsum chart is much more volatile.

In the case of SIP, funds are invested every month. This results in averaging out of purchase price across price points. Which in turn results in much lower volatility in corpus value.

Higher expected volatility may result in lower allocation by investors to equity investments and more allocation to other less volatile but lower-yielding avenues such as fixed income instruments. This can adversely impact the overall portfolio returns.

Loss Aversion

Daniel Kahneman’s Prospect Theory argues that economic agents are more concerned about avoiding losses. For averting loss-making situations human beings are likely to take more risks. This is because experiencing loss gives higher pain compared to the joy experienced by a similar amount of gains.

In investing, the original investment amount acts as a significant reference point for investors. If corpus value falls below the original investment amount, investors experience higher pain. Due to which investors are prone to make irrational decisions in such situations. In the case of the lumpsum approach, this risk is quite high. A sudden drop in prices after making significant lumpsum investments can result in panic selling. Also, Investors may not invest again in the market because of such bad experiences and end up restricting investments in lower return products such as life insurance or fixed deposits.

It is often said that market returns and investor returns are different. This is mainly due to the lower holding period of investors in equity markets. As per the latest AMFI data, only 43.7% of retail investors have a holding period of more than 2 years in equity mutual funds. Anything which helps investors stay invested for a longer period in markets is a great benefit.

SIP approach yields much better results in this regard. Since money is invested in smaller monthly installments over a long period of time, large losses vis-à-vis the original investment amount are rarely experienced. This can help investors to stay invested for longer periods of time in equity markets and take benefit of long-term equity returns of 12-15%.

Distractions

Committing a large amount to an investment avenue is always a time-consuming affair. There are many options available to choose to deploy a large amount of capital in one go. Be it other asset classes such as real estate or multiple ways to take equity exposure such as PMS, AIF, etc. Investing too much amount in other asset classes may leave a very small corpus available for equity allocation resulting in inadequate asset allocation. Or investors may end up choosing high-cost options such as PMS, AIF which may generate lower returns for investors due to their high-cost structures and tax inefficiency.

Monthly SIP investments in mutual funds are a low-cost tax-efficient option suitable to most investor needs and keep such distractions away from investors.

Automated approach

Investor not choosing SIP routes may let the money accumulate in low-interest-bearing options such as savings account or liquid funds. Once such funds are accumulated Investors are more inclined to wait for the right time to enter the market. This further delays the investment decisions. Such delays in investing funds in equities results in lower returns with higher risk. SIP offers an automated approach for investments. Without worrying about the perfect time to enter the market, SIP ensures that equity exposure is built up in an automated manner.

Final Verdict?

SIP is better for:

• Investors who are interested in a systematic asset allocation-based approach to money management.

• Investors who understand that long term equity investments are all about managing your emotions and SIP helps them stay invested for longer period of time.

• Investors who understand that making the investment process automatic via SIP helps in making lesser number of errors in decision making.

• Investors who want to free up their time to focus more on their career and personal life.

Lumpsum is better for:

• Investors who are not bothered about volatility and can remain invested in equities for long periods of time even when they experience significant volatility and distractions.