When is it fine to make lumpsum investments?

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If there’s one thing all mutual fund investors are clear about, it’s that SIPs are a great thing. There’s no debating the many positives that SIPs offer. What also appears to have happened, though, is that lumpsum investments have got the short shrift. Every time you have money to invest, it is not a given that you use SIPs (or STPs). There are times when it’s perfectly fine to be making lumpsum investments.

lumpsum investments are not always bad

Why the SIP love

The one advantage SIPs offer is that it allows you to invest at different market/NAV levels. This is the perfect pill to mitigate the risk that you mistime your investments and wind up investing a chunk of your surplus exactly when markets are expensive. This is also why lumpsum investments are best avoided, as it increases the chances of getting in at the wrong time.

This SIP benefit of investing at different levels is the one that’s talked up the most – and this has pushed an SIP from being a good way to invest to being the only way you should, in your view. So, when you have a surplus to invest, you’re often left wondering if you should invest this at one shot or you need to stagger it.

We are not saying that SIPs don’t reduce the risk of mistiming markets. They do. What we’re saying is that placing excessive importance on an SIP’s ability to help you invest over different points can make you lose the bigger picture.

Here are four scenarios where making lumpsum investments will not hurt. Use this as a guide to know if its best to phase out your investments or get in at one go.

#1 When your investment amount is not significant

This scenario applies when you have already built up some investments and you have a surplus to invest. Look at your investible surplus as a proportion to your total portfolio value and as a proportion to the amount you hold in the fund you want to invest in. When this is a small proportion, any action you take with your surplus will not materially impact your returns or your investment cost.

What do we mean? When the amount you’re investing is not going to increase your investment value by much, how it performs will not have an impact. It is similar to when a fund is, say, less than 5-7% of your portfolio – any gains or losses it makes is too small in your overall portfolio to make a difference.

An example will help make it clearer. Let’s say you invested Rs 5 lakh in the Nifty Midcap 150 in May 2010. By May 2018, this amount would have grown to Rs 14 lakh. Now, consider two scenarios:

  • Scenario 1: You have Rs 3 lakh to invest. As a proportion of your investment, it is above 20%.
  • Scenario 2: You have Rs 100,000 to invest. As a proportion of your investment, it is about 7%.

Here’s how returns in the two scenarios pan out:

As you can see in the table above, the smaller investment amount has a lower impact on the fund’s returns in a lumpsum investment. This is because the amount invested was not enough to average down the overall cost of investment. The period we have taken for running the SIP was when mid-caps (and small-caps) were steadily southward. Therefore, this provided the best period to buy on lows and average costs. Note that you won’t always get such great periods to make staggered investments.

Takeaway: When your investment amount is not enough to make a difference to your overall portfolio or the amount you have invested in that fund (usually, less than 10%) invest at one shot and make it easy on yourself. Using either an SIP or an STP will entail more hassle and will let your money compound in equity for a shorter period.

#2 When investing in debt funds or low-risk hybrid funds

The reason you get jittery investing in one shot is the worry of corrections. But when chances of such mistiming are low, then making lumpsum investments is fine. Similarly, investing at different points – the ‘averaging’ benefit of the SIP – is possible only when the fund is volatile enough or declines steep enough to cause changes in average investment costs.

These aspects are not found in most debt funds. We have discussed SIPs in debt funds here. Volatility in debt funds comes from the bond prices in the fund’s portfolio changing. And that in turn comes from the strategy that the fund follows.

For debt funds that follow an accrual strategy, there extent to which returns can drop is low. These include categories such as ultra short, low duration, money market, floating rate, short duration, banking & PSU or corporate bond. The shorter the maturity profile of the fund, the less volatile it gets. While these funds may sport losses on a 1-month basis, this is not frequent nor is it steep.

For debt funds that follow duration – such as dynamic bond and gilt funds – volatility and loss probabilities are much higher. Even so, for one thing, the extent to which these funds can fall and their volatility pale in comparison to equity funds. For another, if you have been invested in these funds for 2-3 years or more, you may have already built up good returns. therefore, even funds do see losses due to rising bond yields, you may still find it hard to really average down costs.

The table below summaries the volatility and downsides aspects for different debt fund categories. See the article on SIP in debt funds linked above to know in more detail.

The same argument holds for arbitrage and equity savings funds. The lack of volatility and steep losses (barring severe corrections like we saw last year) reduce the risk of getting in at highs. The standard deviation in 1-month returns for arbitrage funds is just about 0.19% considering all 1-month periods over the past 5 years. Since these funds hedge all or the majority of their equity exposure, there is limited scope for prolonged falls that is needed for an SIP to work.

To a good extent, this holds true for balanced advantage funds as well – but as this category houses funds that are very aggressive in strategy, it’s best to know the fund before deciding whether it entails timing risk.

Takeaway – For debt funds, arbitrage, and equity savings funds, lumpsum investments can be done. SIPs do not provide any special advantage. In gilt and dynamic bond funds, you may see a fall in your fund’s returns if the rate cycle ticks higher. But as long as you have your investment horizon right in these funds, these dips will even out. If you intend to invest in balanced advantage funds, know the fund’s strategy and volatility before taking a call.

#3 When switching between funds in the same asset class

We’ve talked about this in depth here, so we’ll skip getting into the details in this article. To summarize what we explained, you can use lumpsums when you are switching between funds that belong to the same asset class. It is not necessary to run an STP or SIP in these cases. This holds even if you are looking at equity funds.

Why? Because you’re holding the same equity investment – you’re just doing so through a different fund. When you look at returns and performance, you need to consider the cost of investment – and this cost is the amount you first invested. It is not the redeemed amount of the fund you are exiting. Unless you made the investment recently and the market corrected very sharply after that, you will not be averaging costs down.

Yes, if markets or your fund corrects, you will see your new fund also delivering lower returns. But remember that you’d see lower returns in your original fund as well.

Takeaway: When switching from one fund to another within the same asset class (equity to equity, debt to debt), then lumpsum investments are doable no matter the investment amount. More details on how to approach this is explained here.

#4 When the market scenario calls for it

No, we’re not asking you to time markets. But there are two ways you can approach investing based on what markets are doing. A word of caution here: this can be tricky and is best done only if you have a general understanding on how to read markets. Else, stick to the three points above to determine if you need to stagger your investments or invest in one go.

One, when it is very clear that there has been a correction – such as early last year. At times you can see that markets have dropped from their peak and have been clocking lower levels steadily for more than a few weeks, you can put in a chunk of money at one go. If you have a large sum to invest – as explained above – you can divide it up into a few tranches to catch a few different market levels.

You can, of course, set up an SIP/STP in such times. But it can be hard to peg the duration for which you need to run this SIP as you will not know how long the correction will last. So if you’re using this route, keep a close eye on markets. Make a quick switch if you see it starting to trend higher.

Two, when markets do not show signs of volatility or uncertainty. The current market scenario, for example, is uncertain given that the full impact of the pandemic and the lockdown is unclear. In such times, phasing out investments can help capture that volatility and there’s risk of making lumpsum investments when markets are high. But if markets are on a steady uptrend, then you can invest in one shot if you’re willing to take the risk and especially if your investment amount is low as explained in the first scenario.

Takeaway: If you have the ability to understand where markets may be generally headed, you can take the call to invest lumpsum. In trying to time a correction, split the lumpsum in at least 2-3 tranches to maximize benefits.

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23 thoughts on “When is it fine to make lumpsum investments?”

  1. Hi Bhavana,

    A little doubt on scenario #1. You mentioned that, ‘Look at your investible surplus as a proportion to your total portfolio value and as a proportion to the amount you hold in the fund you want to invest in’. The example you gave is of 1 fund in a portfolio.

    What if one wants to invest 3% of a portfolio value in a fund which constituents less than 10% of portfolio value. In other words, if portfolio value is 1cr, should one still go for lumpsum investment for an investible value of 3 lacs in a fund whose current value is 5 lacs. Please note that, the investible value is 60% of the fund value in which it is to be invested.

    Regards,
    Parag

  2. contact.thiyagu

    Bhavana,
    Thanks for the article.
    Regarding point#4. Does any number – say P/B, P/E etc – acts as an indicator for the overheated market, so we can take this SIP vs Lumpsum call on basis of that. Say if P/B is hovering around 5, do SIP and say if it is ~2.5 do LS etc.

    1. Bhavana Acharya

      Unfortunately, no, there’s no single metric that lends itself to such timing. It is a blend of different factors and understanding, which is why it is not everyone’s cup of tea. The best is to let SIPs run, and not switch between SIPs and lumpsums. Keep some surplus in liquid/cash (if possible) and when markets correct, you can invest in tranches. – thanks, Bhavana

  3. Hi, what about a case where you know you’re going to be in it for the really long term? Say investing a lump-sum in an index at 20 and forgetting about it for the next 25-30 years? Would a lump sum make sense? Without timing the market?

    1. Bhavana Acharya

      Well, you’d have several such lumpsums in such a long timeframe, so you will be investing at different market levels. But it still does depend on the size of the amount you’re investing versus your total investment. Large lumpsums made at the wrong time can still weigh returns down even after many years. It also, to an extent, depends on the market phase you’re in – since you have no guarantee of what can transpire, making hefty lumpsum investments can be tricky. – thanks, Bhavana

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