Investing comes with many choices. The trouble starts when you start thinking about how to invest and in what. People from previous generation, invested in LIC policies and Fixed Deposits in banks which were safe. Over the years, the lower interest rates and inflation dwindled your savings. However, with Liberalization, we had options galore. Even if they were risky, people invested in it.
You must have heard of the term mutual funds. What is mutual funds? “A mutual fund is a professionally managed investment fund that pools money from many investors to purchase securities”. This term is characteristically used in the United States, Canada, and India, while in other countries across the globe it is called SICAV in Europe and open-ended investment company in the UK.
Mutual funds give small or individual investors access to professionally managed portfolios of equities, bonds, and other securities. Each shareholder, therefore, participates proportionally in the gains or losses of the fund. Mutual funds invest in a vast number of securities, and performance is usually tracked as the change in the total market cap of the fund that is derived by the aggregating performance of the underlying investments.
Mutual funds pool money from the public who invest and use the money to buy other securities, mostly stocks and bonds. The value of the mutual fund company depends on the performance of the securities it decides to buy. So, when you buy a unit or a share of a mutual fund, you are buying the performance of its portfolio or, more precisely, a part of the portfolio's value. Investing in a share of a mutual fund is different from investing in shares of stock. Unlike stock, mutual fund shares do not give its holders any voting rights. A share of a mutual fund represents investments in many different stocks (or other securities) instead of just one holding.
There are two choices you can use to invest – Lumpsum and SIP. An investor can make a one-time investment via a lumpsum investment or can make periodical, over a period of time through a systematic investment plan (SIP). The mode of investment can make a difference in one’s investment portfolio. Both SIP and lump-sum investments allow investors to benefit from potential wealth creation through mutual funds. However, the primary difference between SIP and lumpsum methods is the frequency of investment.
SIPs allow you to invest into a mutual fund scheme periodically, such as daily, weekly, monthly, quarterly or half-yearly etc. With lump-sum investments are a one-time bulk investment in a particular scheme. The minimum investment amount also varies. You can begin investing in SIPs with as little as Rs.500 per month while generally lump-sum investments need at least Rs.1,0000. If you are an investor with a small but regular amount of money available for investment, SIPs can be a more suitable investment option. For investors with a relatively high investment amount and risk tolerance, lump-sum investments can be more beneficial.
Since lumpsum investments need a large amount of money, investors need to know when they are entering the market. Lump-sum investments are most beneficial when you invest when market is down. However, with SIPs, you have the facility to enter during different market cycles. Investors do not have to watch market movements as closely as they would for lump-sum investments.
As SIP leads to mutual fund purchases during different market cycles, the cost per unit is averaged out over the overall investment horizon. More number of units are purchased when market is down, compensating for purchases made during a market high. This can help tide over market fluctuations and even out the cost. Units can then be sold when the market is performing well.
SIPs can get you into the habit of saving frequently. Banks allow you to set up an automatic investment instruction at a frequency of your choice. For investors who can recognize market cycles, identifying a market low and investing in a lumpsum amount in a mutual fund at the right time can garner high returns. This is because of the basic principle of investing – buying low and selling high.
However, an ill-timed investment could result in losses and make you lose self-confidence. This is because an investor whose lumpsum is making losses may hesitate to pump in money again. Seasoned investors with ample market knowledge can benefit from lumpsum investments. Some of the other benefits of lumpsum investments are:
- It can give considerable returns for those with a long-term investment plan (7 to 10 years minimum).
- It can help achieve specific financial goals like investing for a child’s education fund or for a retirement fund.
- It requires a one-time payment only.
- Factors to Consider Before Investing
If you have a bulk amount at your disposal, a lumpsum investment may be a good way to go so that you do not end up spending the money. On the other hand, for a salaried person trying to cultivate a savings habit, SIP would be more suited. When the market is low, lumpsum investment will generate higher returns. If you are unable to identify market cycles, a SIP will help distribute the risk.
When you are choosing a SIP over a lump-sum investment, it should be based on your personal requirements. Factors such as income, financial stability, investment goals, and risk capacity determines the choice of investment.
Market experts believe that SIPs are superior as they can help you tide over market fluctuations and be a good investment option even for novice investors since they do not necessitate frequent monitoring of financial markets.
Indeed, some amount of investment is better than none.