We all want to secure our future. To attain this future security, we all try to create wealth within the available earning recourses. We invest our savings in different financial product in hope of reasonable earnings. Most of the investors prefer investing in various mutual fund products. Investment in mutual funds can be made through a systematic investment plan (SIP) or by making a one-time lump sum investment. Which route of investment is better is a matter of concern for most of the investors?
Both SIP and lump sum investment approaches have advantages and limitations. For some investors lump sum investment may be more advantageous and some may prefer SIP route of investment. It has been observed that since last many years SIP route of investment has become a trend in salaried mutual fund investors.
Difference between lump sum investment Vs SIP investment:
Every investment is made for earnings. The basic difference between a lump sum investment and a SIP investment lies in the approach to investment.
SIP is a methodical approach of investing in which you invest a predetermined amount at a fixed interval on a specified date in a chosen mutual fund scheme. The investors who belong to service class or any one whose earning pattern is periodical prefer investing through SIP route. A person who recently started his career can accumulate a handsome corpus by investing small amount in mutual funds through SIP. He cannot go for lump sum investment because he doesn’t have the sufficient corpus at the early days of his career. If he starts SIP of Rs 25000 per month for a period of 10 years and the expected rate of return is 12% per year, the accumulated amount will be around 58 lakh. If he continues investing the same amount for 10 more years, the accumulated amount will be Rs around 2.5 crore.
It is because interest is calculated on compounding basis. It is the power of SIP investment for a longer duration. First 10 years investment of the same amount resulted in 58 lakhs and the same investment in 20 years resulted in 2.5 crore. The principal invested in first 10 years was Rs 30 lakh and in 20 years it was 60 lakhs.
In general perspective, SIP route of investment is beneficial for new and inexperienced investors having less exposure of market timing i.e. when to enter in the market. SIP gives the benefit of Rupee cost averaging. Your investment rarely gets affected by market fluctuation in the long run.
Lump sum investment is a onetime investment approach in which you put all your money in one or more than one mutual fund schemes. Such investment pattern is suitable for a seasoned investor having a good sense of market timing and Patience to hold the investment during the market turbulence.
Suppose you invested your money in lump sum manner in an equity scheme when market was low and the market goes up as per your expectation. You will enjoy big gains from your lump-sum investments.
Simultaneously, It is equally possible that markets remain low and has even fallen down by 30 percent. Within no time your investment will shrink by 30 percent. Instead of earning, your principal reduced by 30 percent. This situation may be highly disappointing for majority of investors. Volatility is a feature of financial market. Market moves in its own tune. It may pick the height within a month also.
In general, when the market and stock valuations are low, a lump sum investment is advantageous but it is not a thumb rule. It is because the accurate prediction of bottom line of the down trend is rarely possible.
Comparison on returns -SIP Vs Lump sum investment:
Let us compare the returns on investments through lump sum route and SIP route through an example:
Suppose you have 240000 rupees for investment. You invested in a lump sum manner for two years and realized return on investment @ 12 percent CAGR on investment. At the end of two years your corpus will be Rs 301056.
If you invest the same amount with an expected return of 12 percent through monthly SIP route then every month you will invest Rs 10000 for a period of 24 months. At the end of two years your corpus will be Rs 272432.
This example reflects us that the lump sum investment may be better in terms of returns but this return can be achieved by few seasoned investors only. Also, you invest all money upfront. A new and inexperienced investor may or may not realize such returns through lump sum investment. Market may result in a different direction also.
In SIP investment you are investing your money in installments. After paying your first investment of Rs 10000 Remaining amount of Rs 230000 is still in your hand and may earn returns for the remaining period. You can park the remaining amount in a debt fund and let it grow with reasonable returns. Alongside you are taking the benefit of cost averaging also. Risk of loss is also very low as compared to lump sum investment.
Taxation aspect – SIP Vs Lump sum investments:
Capital gain is the amount of profit earned from the sale of a capital asset. It may be mutual fund units, stocks, bonds, real estate etc.
Specifically for mutual funds, it can be defined as profit realized due to the appreciation in the price of the fund units in mutual funds. Capital gains are taxable in the hands of investors.
Capital gain tax is levied on SIP as well as Lump sum investment at the same tax rate but the tax calculation method is different for both investment patterns. Capital gain tax is classified in two categories on the basis of holding period of units by an investor. It is known as Short Term Capital Gain (STCG) and Long-Term Capital Gain (LTCG). Applicable tax rates are different for Short Term Capital Gain and Long-Term Capital Gain. Tax rates are also different for Equity oriented SIP schemes and Debt oriented SIP schemes. It is shown in the given table.
|Fund Category||Short Term Capital Gains(STCG)||Long Term Capital Gains (LTCG)||Applicable tax rate on STCG||Applicable tax rate on LTCG|
|Equity funds||Less than 12 months||12 months and longer||15% + cess + surcharge||10% + cess + surcharge Rs 1 lakh per year is tax-exempt.|
|Debt funds||Less than 36 months||36 months and longer||As per income tax slab rate tax provisions||20% + cess + surcharge (With indexation)|
Now let us understand the difference between calculation of capital gain tax in SIP and Lump sum investment through this example-
In lump sum investment Capital gain taxes are calculated simply on the basis of holding duration of the on the total investment amount according to the tax rate given in the above table.
Suppose an investor A invested Rs 24 lakh through lump sum route for a period of 11 months in equity fund and redeemed it just after 11 months. He earned return of RS 264000 @ of 12% on this investment.
Since the investor redeemed his investment before 12 months, it is treated as short term capital gain and taxed @ of 15% + cess + surcharge
He will have to pay capital gain tax Rs 39600 + cess + surcharge as applicable.
The same investor A invested Rs 24 lakh through lump sum route for a period of 24 months in equity fund and redeemed it after 2 years. He earned return of RS 6,10,560 @ of 12% CAGR on this investment.
Since the investor redeemed his investment after 12 months, it is treated as Long term capital gain and taxed @ of 10% + cess + surcharge after deducting the tax exemption of Rs 1 Lakh.
Taxable amount = 6,10,560 – 100000 = 5,10,560
Tax payable = 51056 + cess + surcharge
In SIP investment tax is calculated on holding period. Since SIP is a periodical investment of chosen frequency. With every frequency of investment in a selected scheme you purchase a certain number of fund units. When you redeem the scheme units, the redemption is processed on a first-in-first-out basis. This means that the unit you purchased first will be the made available first for redemption processing and the same sequence will continue. It is called the FIFO method.
An investor B invested in an equity fund through SIP route as per below given pattern
|Date of SIP investment||Amount invested||NAV||No. of units||Selling price||Gain/Loss||Total Gain/Loss||Tax category|
The investor B has started investing in an equity mutual fund scheme through SIP in the month of July 2019 for one year. He started investing Rs 10000 on monthly periodicity and invested till June 2020. In the month of July 2020, he sold all his units at an NAV of 130. The capital gain will be calculated month wise because the sip investment which was made in July 2019 will complete the holding period of 12 months in July 2020 and therefore fall in LTCG category.
It will be calculated @ of 10% with cess and surcharge as per LTCG taxation process. Since Long term capital gain up to Rs 1 lakh is exempted from tax liability, this earning of Rs 3000 will not attract any tax. If this amount exceeds the exemption limit i.e. Rs 1 lakh, LTCG tax @ 10% with cess and surcharge will be applicable on the amount above Rs 1 lakh. Indexation benefits are not applicable for equity LTCG tax calculations.
SIP investments made from August 2019 to June 2020 will fall under category of Short term capital gain since the holding period is less than 12 months. The total STCG for this period is Rs 37131.09. In the month of May 2020 and June 2020, there is a capital loss of Rs 1333.20 and Rs 1875. It will be set off with the Short term capital gain. Now on STCG of Rs 37131.09 the tax will be calculated @ 15% plus cess and surcharge. It will be Rs 5570 plus applicable cess and surcharge.
Best approach of investment in mutual funds:
For a general investor, it is better to invest in an appropriate combination of SIP and lump sum investing. The ratio of this combination depends upon the investment objective, risk bearing capacity, ability to analyze the entry and exit timings in the market, earning and saving pattern of the investor. Some investments are made to avail the short term opportunities in the market and some are made in line of your future financial goals. A smart investor always classifies their investment portfolio in core and satellite investments segment.
SIPs are more cost-effective, less risky and convenient to begin with where as a lump-sum investment gives opportunity to yield higher returns, particularly during bull markets.
The key to smart and successful investment in both the investment routes are:
- Always take a well-informed investment decision in line of your investment goals.
- Don’t get influenced by the various behavioral biases and herd mentality.
- Keep a track on your investments on various parameters like scheme performance with its benchmark, Status of fund manager, portfolio turnover ratio, change in interest rate due to government policies etc.
- Don’t rely on rumors. Always analyze the scheme through reliable research based data source.
- In case of any confusion, take advice of an expert investment professional.