Lumpsum or SIP/STP

Original Post and discussion

This is quite confusing to many people, since the finance world touts SIP (Dollar Cost Averaging in foreign terms) as the best way to invest.

Definitions:

SIP (Systematic Investment Plan) = one invests a fixed amount of money at a regular interval (daily / weekly / monthly / quarterly). In short, it is transfer of money from cash to a particular asset (mutual fund / direct equity called the DIY-SIP or other such names).

STP (Systematic Transfer Plan) = one switches from one mutual fund to another at regular interval, if the money is already with the AMC (asset management company).

Lumpsum = The investment of the whole lot of money into an asset.

Basic Guiding Principle: The overall average return of various asset classes vary. In the long term, the cash and cash-equivalents produce low but fixed returns, while the equity assets produce high returns with volatility (in most cases).

Eg. 1:

You have got 10 lakhs, and your investment horizon is >10 years. So should you put your money in

1. 10L in an equity fund (or equity-oriented hybrid fund) on day 0. OR

2. Put your money in a short-term debt / liquid fund and start a STP into the equity fund at monthly (120 installments) / yearly (10 installments) intervals.

3. Keep your money in your bank account and start SIP into the equity fund at 120 monthly / 10 yearly intervals.

Since the investment horizon is quite long, it is much better if one chooses option 1 (whatever be the sensex levels). Option 3 will give you lesser overall return, because the long term return from the cash component will be quite less than of the diversified equity asset class.

There is one study released by Vanguard which supports the above.

Eg 2.

You do not have 10L, but can invest at a rate of 8k per month (Total principal amount 10L, over 10 years). So should you, since lumpsum is better than SIP,

1. Start putting your money into your account / liquid fund over all those 10 years, and then invest lumpsum at the end of 10 years, OR

2. You should start putting the money directly into Equity as a regular SIP.

The answer is obviously 2, since you will not be missing out on all those 10 years of equity returns.

TL;DR, if you have money to invest for a long term, put that money into a diversified equity asset ASAP. If you have got lumpsum (eg, bonus money or tax refund), then invest lumpsum. If you have regular stream, then invest at a regular interval.