The most important principle in lump-sum investing, especially in equity funds, is to maintain your calm and equanimity.
Most of us are aware of the merits of systematic investment plans (SIPs). As compared to lump-sum investing, SIP is simpler and more elegant over a longer period of time. But there are occasions when lump-sum investing becomes essential. For example, you may have received a large bonus from your company or you may have sold off a piece of land or property. These are situations that may necessitate lump-sum investing. The question is; how do you go about it?
Get a benchmark idea of how market valuations are
Let us start with a caveat, “It is impossible to time the markets”. Irrespective of your judgement, finding market bottoms to invest and finding market tops to sell are next to impossible. But you can use the P/E ratio (price to earning) as a benchmark. While calculating P/E, consider the earnings of the last four quarters. Projected earnings can be at times misleading. Over the last 20 years, the Nifty has created a long term bottom around 10-12 times P/E and long term tops at around 25-28 times P/E. Your decision to invest your lump-sum money can be driven by whether the Nifty P/E is closer to the lower end or the upper end. If you buy equity mutual funds when the P/E is around 14, then you stand a better chance of ending up profitable rather than if you invest when the P/E is closer to 22. Either ways, you need to invest for the long term (minimum of 3 years).
If you are buying lump-sum, then stay invested for the long haul
Had you bought Indian equity mutual funds in January 2008, you have probably had to wait for six-seven years before getting positive returns. Of course, if you had applied for the first factor mentioned above, then you would not have invested a lump-sum in January 2008, when valuations were already well above 22 times P/E. But even if you had bought in September 2008, when markets had already corrected substantially, you would have still seen your equity funds deep in the red because the markets eventually bottomed out only in March 2009. So if you invest a lump-sum, don’t be myopic.
Before you invest the lump-sum, articulate your return and liquidity expectation
This is an extremely important point and partially an extension of previous point. If your lump-sum money is going to be needed at the end of the year to pay the margin for your home loan, then you are better off putting the money either in a debt fund or in a liquid fund. From a one-year perspective, they can be more predictable and secure compared to equity funds. Similarly, if you invest lump-sum in equity funds do not expect outperformance within one year. At least give it three years to show outperformance.
Patience and equanimity is the key to lump-sum investing
The most important principle in lump-sum investing, especially in equity funds, is to maintain your calm and equanimity. For example, investors who bought tech sector funds in 2002 when NAVs had fallen 70 percent below par, still had to put up with another 30 percent correction in NAV. Of course, over the next five years all these tech funds became multi-baggers many times over. But keeping patience and equanimity in the midst of volatility is easier said than done. That is a risk you run in lump-sum investing and you need to be calm and patient.
How about marrying lump-sum investment with a hybrid SIP?
This is a way out if you are confused about timing the market, yet have a lump-sum in your hand. Invest the money in an ultra-short term fund or liquid fund and set an STP (Systematic Transfer Plan) to regularly allocate a fixed sum to your equity fund investment each month. That way you are saved the worries of timing the market and your liquid fund earns higher than your bank account.
That is surely a smart way to put your money to work!(The writer is founder of Right Horizons.)