Investors often think that SIP is a product for investment, but they are confused between SIP and mutual funds. SIP is, in fact, a mode of investment in which one can invest in a mutual fund or any other investment products.
So, first, let us discuss the modes of investment.
SYSTEMATIC INVESTMENT PLAN (SIP)
It is a mode of investing in mutual funds, shares, or other investment products wherein an investor can invest a fixed amount at regular intervals, which can be monthly or quarterly. This approach allows for small, periodic investments rather than investing a lump sum amount.
Advantages of Systematic Investment Plan (SIP)
1. Financial Discipline: Investing in a disciplined manner, by contributing small amounts periodically, can help build substantial wealth in the long term. Remember, “discipline is key to success.”
2. Rupee Cost Averaging: One of the significant advantages of SIP is cost averaging. It spreads the investment/purchasing cost over the investment period. When the Net Asset Value (NAV) is higher, you get fewer units, and when NAV is lower, you acquire more units.
3. Power of Compounding: Compounding means earning interest on interest. You can fully leverage the power of compounding by starting your investment as early as possible, as it requires several years to grow significantly.
4. Pocket-Friendly: SIP allows you to start investing with a minimum of ₹500. This small amount makes it financially accessible to many individuals, reducing financial difficulties.
Disadvantages of Systematic Investment Plan (SIP)
1. Only Predefined Amounts Can Be Invested: SIP limits you to investing only a predefined amount. If you wish to invest more due to market corrections or receiving bonuses, you cannot do so through SIP and must invest a lump sum.
2. Limited Options for SIP Date: SIP requires you to select a date in advance for your investments. Most funds offer limited date options (e.g., 1st, 3rd, 5th, 7th, 9th, 11th, etc.). There is no reported benefit to choosing a specific SIP date, but it can be inconvenient for those with cash flows that don’t align with these dates.
3. SIP Returns Are Lower in Bull Markets Compared to Lumpsum: While SIP offers rupee cost averaging, it tends to yield lower returns during bull markets because the NAV rises with each installment due to averaging.
4. Unsuitable for Those with Unpredictable Cash Flow: Investors with unpredictable cash flows may find SIP unsuitable. Since SIP installments are fixed and regular, unstable cash flow can lead to missed payments and penalties.
Lumpsum investment involves investing the entire capital in any investment vehicle in one go, rather than at regular intervals. Now that we understand these two different modes, let’s explore the advantages and disadvantages of each.
Advantages of Lumpsum Investment
1. Potential for Higher Returns: Lumpsum investments made at the right time can provide more units at a lower cost, potentially yielding higher returns when markets are bullish.
2. Market Volatility: Investing a lump sum in mutual funds or stocks allows your investment to react to market conditions. When investing during market corrections or at low points, you can acquire more units at lower prices, which may lead to significant returns when the market recovers.
3. Time Constraints: Lumpsum investments can be completed in a single transaction, without the obligation to invest at regular intervals like SIP.
4. Less Commission: Lumpsum investments often have lower overall commissions compared to making multiple small investments.
Disadvantages of Lumpsum Investment
1. Requires a Large Sum of Money: Lumpsum investments require a significant amount of capital. If you do not have the funds readily available, you may need to sell existing holdings, incurring opportunity costs, or borrow money, leading to loan repayment costs.
2. Market Volatility: While market volatility can work in favor of lumpsum investments, it can also be a disadvantage. Investing during market peaks may result in acquiring fewer units at higher prices, potentially leading to lower returns if the market corrects.
3. Difficult to Manage: Lumpsum investments require a single, well-timed decision regarding the amount and timing of the investment.
4. No Rupee Cost Averaging: Unlike SIP, lumpsum investments do not benefit from rupee cost averaging, as investors must bear the full brunt of market fluctuations.
Both SIP and lumpsum investments have their unique merits and drawbacks. The choice depends on individual circumstances and market conditions. Consider lumpsum investments during market downturns and opt for SIP when markets stabilize or recover. Remember, consistency in long-term investing is the true path to wealth creation.
I am a third year finance student curious to know more about financial market. I love to read, write and learn new things. With learning and experience the blogs and newsletter we write tend to spread good insights among the readers.