A recent article in Time magazine’s Business section quoted a report from fund house Vanguard that said investors with lump sum were better off investing in the markets all at once. It had a scenario that demonstrated that the longer one took to invest, the lower the returns. That means lump sums are better than SIPs.
Can this view hold good in the Indian markets? Not necessarily and here’s why:
Lump sums for very long periods do work very well under broadly two scenarios: one, long periods of sustained bull rallies as was the case in the last decade in the Indian markets. Two, when there is limited volatility in the markets, thus providing little scope for your funds to average costs.
Structural bull run
The first point is broadly true of funds that have seen a decade ending now. For instance, a multi-cap fund like HDFC Equity returned 29.6 per cent compounded annually point-to point between 2002 and 2012 while its SIP would have delivered an IRR of 21 per cent. This is true of mid-cap funds like Sundaram Select Midcap. This ten-year period was marked by a sustained bull run (the turbulence in recent years notwithstanding) with the Sensex moving from 3200 to 18300 now.Over such a long rally, your SIPs returns would be marginally dented by the fact that you have been buying additional units at higher costs for a good part of the period.
But you need to keep in mind that the last decade same a multi-fold jump in markets as it was in this period that foreign money inflows saw a pick up. Hence to expect a similar six-fold jump in the next decade may be hard. We have already gone past five years post 2007, with the market remaining flat – the Sensex down by an annualized 1.5 per cent.
Also, unlike the US, where markets are less volatile, Indian markets have been marked by high volatility. It is these markets that provide scope for rupee cost averaging – that SIPs do. Take the case of last five years. The funds mentioned above, HDFC Equity or Sundaram Select midcap, managed 7-10 percentage points more returns through SIP compared with lumpsum between 2007-12, suggesting that averaging has worked wonders in a volatile market. HDFC Equity’s SIP IRR was 12 per cent as against lump sum return of 5 per cent annually.
That said, compounding still works wonderfully in lump sum when the investment stays for a longer period; unlike SIPs where subsequent investments are compounded for a shorter period. So how do you make the best use of compounding in SIP?
Start SIPS early, continue, stop and then hold. The illustration below gives the advantage of investing small sums early on and then holding as opposed investing till the end of your goal. In this case to achieve Rs 2.75 core when you turn 60, you should have invested Rs 2,00,000 as lump sum at the age of 21! It is not often that you would have a large sum at one go to invest. And if you did have and invest at the wrong time (like in 2007), then chances of your lump sum growing well will be bleak.