ELSS vs SIP
Vidhi was looking to make some investments in the stock market to diversify her portfolio and also save tax. Since she had no experience in picking the right stocks, she considered mutual funds, and had heard that equity-linked savings schemes (ELSS) offered tax benefits. However, she didn’t realize that there were two ways of investing in an ELSS fund, and got conflicting advice from financial advisors. One recommended that she invest a lump sum amount while the other said she should start a systematic investment plan (SIP) and invest small sums each month. This contrary advice left her confused about investing. So what should she have done?
Difference between lump sum and SIP
A lump sum investment in ELSS meant that Vidhi had to put all her money at one go in the scheme and wait for the investment to grow. As compared to this, a systematic investment plan or an SIP involved investing small sums of money on pre-decided dates each month for a predetermined period (a minimum of three years in an ELSS scheme).
In an SIP scheme, you spend a fixed amount each month irrespective of the price of each unit. This means some units will be purchased at a higher price, while others will be bought at a lower price. When share prices are low, Vidhi will get more units for the same price. And when share prices are high, she will get less units for the same amount. So an SIP averages the cost of investment over a longer period of time. This is called rupee cost averaging.
These two different investment strategies, SIP or lump sum, can be used to invest in not only ELSS, but any mutual fund. But which investment strategy would work better for Vidhi -- SIP or lump sum?
Which investment strategy works better?
If you look at ELSS vs SIP, the success of the investment strategy depends on the performance of the market. If the market is in a continuous upswing, or in a bull phase, it can be safe to assume the price of ELSS units will also rise in tune with the trend. This means each SIP will buy fewer units. So investing through SIPs may not be ideal for Vidhi in this situation. And since an ELSS scheme has a lock-in period of three years, her investment is not liquid and she cannot withdraw funds in unfavorable market conditions. If the market has been continuously rising, her gains may not be a lot.
On the contrary, if Vidhi make a lump sum investment when the market is rising, her investment could quickly multiply. NAVs will keep going up, and if she chooses to do so, she can book capital gains after the three-year lock-in period.
The argument tilts in favour of lump sum investments when the market is experiencing a bull phase. But when the market is experiencing a downturn, each SIP will get Vidhi more units, which in turn will result in larger capital gains when market conditions improve. If she make a lump sum investment all at once in a falling market, she could end up with a lot of losses if the situation does not improve.
One option if for Vidhi if she doesn’t want to make the choice between lump sum vs SIP, is to stagger investments in times of market volatility but invest in a lump sum when the markets start to rise continuously. However, this strategy requires continuous market monitoring to get the timing right. And as most market pundits will tell you: there’s no surefire way of telling which way the stock markets move. Any miscalculation could lead to huge losses for Vidhi.
If Vidhi wants to maximize returns, and has a large sum of cash available, she could make a lump sum investment in a debt fund and invest in an ELSS SIP scheme through a systematic transfer plan. This means a small amount will be redeemed each month from the debt fund and invested in the ELSS SIP. This way, her money continues to earn a fixed but lower rate of return while she gets the benefit of rupee cost averaging and higher returns by investing in an ELSS fund.
Vidhi can take a decision based on her monthly income and on the condition of the markets. By keeping her options flexible, she can make the best of both these investment choices.
The most important point to remember in the lump sum vs SIP debate is lump sum investments work better if you have the money to spare and are able to get the timing right. If you want to invest small amounts you can spare every month, the SIP strategy will be more beneficial for you. You can maximize returns by investing small sums rather than waiting to accumulate funds to make a lump sum investment.