Amit Trivedi Karmayog Knowledge Academy
There are some questions that never die. They keep coming back time and again. It has been more than a decade and a half since Franklin Templeton introduced the concept of SIPs in India. However, we keep coming across the question of comparison between SIP and lump sum investments. Which approach is better – investing through SIP or through lump sum investment? Which of the two will generate higher returns in coming future?
Can the two approaches be compared, really? One has come across many articles trying to do that. One has come across arguments that suggest one is better than the other.
Let us see if such comparison is fair.
At the outset, there is a difference between the cash flows – in case of lump sum investing, the investor has money on hand that can be invested. Whereas in case of SIP, the investor may not have lump sum on hand and may have regular surplus expected in future. If a person does not have lump sum money available to invest, there is no question of one investing at one go. Similarly, if there is a person whose future income is uncertain, SIP is out of question.
Another reason why the comparison is unfair is that because investments are done at different points of time. Let us elaborate on this point:
- Mr. ABC invested a lump sum of Rs. 5 lacs in a fixed deposit for a period of 5 years at the rate of 8% p.a. At the end of 5 years, he got Rs. 7.35 lacs.
- Mr. XYZ got a chance to invest a recurring deposit that offered 9% p.a. He invested a sum of Rs. 1 lac per year for a period of 5 years. Although the rate of return was higher, he ended up with Rs. 5.98 lacs.
In terms of percentage returns, Mr. XYZ got higher, but Mr. ABC ended up with more money.
This happened because Mr. ABC’s full amount was invested for the entire period of 5 years. However, Mr. XYZ’s investment was not completely invested for the full term since the money was getting invested in small chunks.
This is a futile comparison. There is no point wasting time over such discussions. Whether one opts for lump sum investment or SIP depends on whether one has lump sum to invest or a regular savings.
However, the debate continues in the investing circle and often the percentage returns lead some to believe that higher that number, better the investment.
Way back in secondary school, we studied the Mathematical equation to calculate the amount accumulated through compound interest.
FV = PV * (1 + r) ^ nWhere,FV = Amount accumulatedPV = Amount investedr = Rate of interestn = Number of compounding periods (could be years, months or any such unit of time)
The more time you give to the investment, higher the amount accumulated since the power of compounding increases as the time goes by.
In the example we saw earlier, in case of lump sum investment, the whole amount was invested for 5 years. As against that, in case of SIP, it was only the first installment that was invested for the full five years. Each installment thereafter each got one month less. Be careful. Understand the relation between the amount invested, the time invested and the rate of return earned. Giving your investment more time is wiser than taking undue risks to earn that extra 1% return per year.
The author runs Karmayog Knowledge Academy. The views expressed here are his personal views. He can be reached at amit@karmayog-knowledge.com.
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