Thursday, June 25 2020

Lumpsum versus SIP

SIP was introduced by Franklin Templeton Mutual Fund more than 15 years back. Major people have the perception in their mind that if they invest their saved money altogether in investment activities then they will get much better returns in the long run. They are right.

If the market grows continuously, then lump-sum investing gives higher returns whereas if it falls continuously, then SIP investing is better (lesser losses than that of lumpsum investing in such scenario). It depends on the future sequence of returns that the investor gets.

Due to their structural nature, SIPs reduce this risk of being completely wrong as the investments are spread out. So asking whether is this the right time to invest in SIP is immaterial as SIP spreads out your investments. Of course, your returns will depend on how the markets play out during the spreading-out period.

For small investors, SIP is also suitable for their cashflow perspective. They rarely have access to a large lump sum that is ‘surplus enough’ to be available for long term investing. Remember that SIP is a tool to optimize returns and match your investment needs to your cashflows. It is not a magician’s magic to generate superior returns to lumpsum investing. Read that again.

A smart investor would recognize the market bottoming out and invest in one go. But we all aren’t smart. So if you aren’t sure if it’s the right time to invest in one go, you can even deploy your lump sum gradually. One way is to put lump sum investment in debt mutual fund and gradually deploy the money using STP or Systematic Transfer Plan into an equity fund.

SIP was introduced by Franklin Templeton Mutual Fund more than 15 years back. The idea was simple you buy mutual fund units every month for a fixed amount. When the markets are low you would be able to buy more units and in high markets, you’ll be able to buy lesser units.

Generally, it is seen that most of the people invest their money in a lump sum. Lump-sum means your heavy amount of money or a major part of the saved money which is invested altogether. So, major people have the perception in their mind that if they invest their saved money altogether in investment activities then they will get much better returns in the long run. They are right. The one-time large investments for a longer period will provide them a much higher return when they will be withdrawn at their respective maturity periods. Although one could invest a lump sum money only when he has a good amount of money with him. In the absence of a fair amount of money, nobody can think of investment in a lump sum. So it is essential that if you are thinking of investing your savings entirely at one go then you first should have a proper money-saving, and secondly, you should have a long term plan.

Who should invest in the lump sum plan?
    Those who earn fairly every month and left with a fair amount of savings. Those who have the goal to earn an investment for 5 years or some long duration.
    
The more time you give to the investment, the higher the amount accumulated since the power of compounding increases as time goes by. Giving your investment more time is wiser than taking undue risks to earn that extra 1% return per year.

At an annual return of 15 percent, Rs 15 lakh would be worth around Rs 60,00,000 at the end of 10 years. Assuming the same annual rate of 15 percent, your monthly SIP of Rs 8,000 would yield around Rs 22,30,000 at the end of 10 years. However, it all depends on how much money you currently have in your hand. If you have Rs 15 lakh to invest, you should ideally park the money in a liquid fund and start a Systematic Transfer Plan (STP) over the next 50 weeks. That is Rs 30,000 per transfer. This method will help you to invest your entire money and earn returns from the liquid funds on a reducing balance method. The amount invested via STP should be in a diversified equity fund. At the end of 50 weeks, you would be fully invested. If you don’t have a lump sum to invest, you should adopt the SIP route.

a SIP does not reduce investment risk in any way. They do reduce the risk of irregular income to mutual fund houses and their sales guys. We can only invest if we have money and when we have money. If I do not have a lump sum (and this means I can properly define what a lump sum is), then I don’t care about this question. If I do have a lump sum, then I should ask, “is there any benefit in spreading that lump sum over a few weeks, months or years (some recommend this!), instead of putting it into the market all at once?” If I do have a lump sum, then I should ask, “is there any benefit in spreading that lump sum over a few weeks, months or years (some recommend this!), instead of putting it into the market all at once?” There is not much difference between a lump sum and investing it over a few weeks or months (STP). Amusingly this is true whether this is true over the short-term or long-term!

Use MFs with caution for medium-term (less than 10 yr) goals. Of course, stay away from them for short-term goals. Just because you have started a SIP hardly means you will achieve your goal. There is a strong enough chance that you won’t and a decent chance you will lose money! Choosing an equity-oriented balanced fund for a 5-year investment duration is madness.

There seems to be a common perception that those who invest via SIPs are expected to do nothing else but invest systematically.  Thanks to certain “advisors” many investors believe that all one has to do to get “good returns” from equity is to continue a SIP through market ups and downs. Then it will all turn out okay in the end. This is an amusingly simplistic assumption. Then are those who incorrectly believe that SIP is a method to minimize market risk, while all it does is buy at random market levels each month.  The accumulated corpus via SIP is exposed to the entire ups and downs of the market.

There is no such thing as compounding in a mutual fund or a stock or anything related to the market. You buy at the current price and sell at the current price after a while. The selling price may be higher or lower than the buying price. We use the mathematics of compounding to understand how much the investment has grown (or fallen). That is all. Other than that, there is no magic of compounding or the magic of compounding. Do not take the nonsense peddled by sales guys seriously. If you want to enjoy the power of compounding, get a fixed deposit, recurring deposit, PPF, etc.

I have a mutual fund SIP running, how does one compute annualized return for that?
    This is done by an approximation technique that you studied in 11th or 12th standard math. Since there are multiple investments involved, we try and find a single annualized return number that will fit each of them. This is known as the internal rate of return (IRR). When the investment dates are random, the math is modified a bit and the method is then known as extended IRR or the XIRR.

I am planning for a 15-year investment and want to hold 60% equity in the initial years. What can I expect during this investment?
    When you hold 60% equity, expect the entire portfolio to fall in value by at least 40-50% (not making this up). That is not going to be easy to face for anyone, expert or novice.

Friday, April 17 2020

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Tuesday, September 17 2019

Welcome to finance.ekvastra.in!

I am an AMFI registered Mutual Fund Distributor and I also hold a Retirement Advisor license. I would be happy to help you in your financial planning!