SIP or Lumpsum Investment: Which is the better option?
Created on 30 Mar 2020
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Updated on 16 Nov 2022
SWP and SIP or a bulk payment
The investment world is filled with acronyms making it difficult for a commoner to interpret or comprehend it. SIP and SWP are two such acronyms that you might constantly hear when you go in for investing. Especially, when you are about to invest in mutual funds, the one basic question which the broker might ask you is whether it is a lump sum or SIP-based investment. Without knowing the actual meaning and benefits of it most of us might simply choose one falling victim to the advice of brokers or friends. So what exactly are SIP and SWP? Should I go for SIP or a lump sum?
SWP and its benefits
An SWP or Systematic Withdrawal Plan helps an investor to withdraw the amount from his investment at a predetermined time. He may withdraw either monthly or quarterly or yearly according to his will. This is applicable in most mutual fund schemes. There are two types of withdrawal options available.
Fixed withdrawal plan- it allows the investor to withdraw a specified amount at regular intervals by selling the units held.
Capital appreciation- here the appreciated amount or the returns generated will be deposited into the investor’s account at the specified date or time.
For instance, you have 2 lakhs in hand. You invested the amount in policy QPR and it offers a return of 10% annually. You want to withdraw a certain amount annually to meet your expenses. In such a case, SWP can be of great help. You might instruct your fund manager to direct the amount which has been accumulated as a result of capital appreciation to be deposited into your account. In this case, you may ask your fund manager to deposit, say 10,000 into the account quarterly.
There is a misconception among many that SWP can benefit only a retiring couple. But in reality, an SWP can help you meet your expenses, support your child’s expenses, pay your EMI, etc. It happens to be a fixed and regular income stream. It is far better than dividends. They are tax-efficient and flexible when compared to other withdrawal plans. However, your SWP amount will be considered as a Long Term Capital Gain (LTCG) and taxed between 10-30%. Further, the exit load charged also happens to one of the major drawbacks.
SWP will always give you an upper hand when compared to other withdrawal plans like MIP (Monthly income plan), etc. SWP will pay a fixed amount at a predetermined period whereas other dividend plans are dependent upon the company's decision. That is if the company wants to pay dividends then it will. But in a particular month or quarter if it wants to retain its dividend then you will be hit hard. Also, these dividends are subject to DDT (dividend distribution tax). But SWPs are tax-efficient. This means an investor who is making withdrawals in small sums may avoid tax. SWP protects and safeguards you against market risks. But you cannot expect the same in other payout plans. SWP can be a great backup on which you can rely. For instance, let's take the current lockdown where a lot of people are staying at home and are away from jobs. In times like these, a guaranteed income flow can be of great assistance.
SIP and lump sum
In lump sum based investment, you invest all your money at one shot. But SIP or Systematic Investment Plan allows an investor to invest in the selected scheme at planned intervals. Not all will be able to invest a lump sum. In such a case he or she can adapt SIP and invest the corpus at stipulated intervals. But on the other hand, one who has a lump sum in hand will have to make a conscious choice between the two.
Benefits of SIP and lump sum include,
SIP cultivates discipline among the investors. It assists you to handle your money in a better way. On the other hand in lump sum investment, you just have to invest once. After that, you can stay tension free.
SIP saves you from the market fluctuations and offers an opportunity to see a fortune in every up and down.
It also helps you to deal with the market risks and spread it over the various installments.
So, which one? SIP vs Lump sum
Under a normal market, a lump sum would do more good. Say Mr. X has 2,40,000 in his hand. If a unit cost 10 each, then he will be able to purchase 24,000 units. So the 1 lakh will stay invested during the entire period of 12 months. Hence, your investment will receive a longer period to grow. But this is not possible in a SIP-based investment.
But the market is not going to be the same every day. Just like the weather, there is going to be a change every day. Hence, in a falling market SIP is much beneficial. Let’s stick to the first example. If Mr. X invested the same 2,40,000 in SIP-based investment then he would benefit a lot from the market fall. Say initially the unit costs 10, so he buys 2000 units spending Rs. 20,000. But in the next month, the price of the unit has fallen to 9. Then he will be able to buy 2222 units. So he would have an additional 222 units when compared to the first case where he invested it as a lump sum.
Instead of falling if the market rises. Then the lump sum investment would be much effective. Because when Mr. X is purchasing units under SIP during a market fall, he will be able to buy only lesser and lesser units. When the price of the unit was 10 each, he was able to purchase 2000 units. Further, if the markets rise and the price of the unit increases to 11 then he will be purchasing 1818 units. Hence he will have 181 units less than the first case. Thus a lump sum will save you against the rising market.
So what should I do?
Based on the units held your returns will also vary. For a SIP you will need to have a regular cash flow. However, an SIP will help you stay calm even if the markets are unfavorable. But investing a huge amount will only cause panic. SIP investments are suggested for both short and long term investments. But a lump sum has to be held for the long term to eliminate the market fluctuations. A lump sum investment is quite risky when compared to SIP.
Imagine you have a packet of instant noodles with you. Along with it, you have the masala, vegetables and enough water to cook it. Whether you put all the ingredients at the same time or equal intervals one after the other, it is not going to alter the result greatly. But there are going to be slight variations in the taste. Similarly, whichever mode of investment you adapt, make sure that it fulfills your financial goals and is in line with various other factors that affect your returns. In simple words, it is highly important to take note of the slightest variations not in your noodles but your investment plans and payment mode as well. Because your returns can vary largely based upon the choice you make.
I guess that you have a far better idea of the few most popular acronyms and how they affect your returns. Be it SIP or SWP or lump sum, each has its advantages and disadvantages. The best investor sees an opportunity at every disadvantage. Choosing the mode of payment is equally significant as choosing a good mutual fund scheme. So make a wise and prudent choice.
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