SIP or Lumpsum: Which one to choose?

Mutual fund investments can be made by making a lump sum payment or through a Systematic Investment Plan, popularly called the SIP. If an investor chooses to make a lump sum payment, his entire amount gets invested and he gets all the units allotted at the prevailing NAV. However, in the case of SIP, the investor pays in instalments over a period of time and the units get allotted every time he pays the instalment at the NAV rate prevailing a day prior to the date of payment. So, the rate at which an SIP investor buys units may be different every time, depending on the market conditions, while in the case of lump sum investor, all the units are allotted at the rate prevailing on the day prior to the date of payment.
 
Now, SIP is a facility offered by asset management companies (AMCs) to facilitate investment in small amounts on a regular basis by the investors. An investor can invest in a mutual fund in monthly or quarterly instalments through an SIP. Some mutual fund schemes offer weekly or daily SIPs too.

Of the two options, namely, lump sum and SIP, it is generally believed that the option of SIP is a better way of dealing with market volatility. This is because SIP offers the investor the advantage of averaging the cost of investment as, for the same amount, he buys less number of units when the market goes up and more units when the market goes down.

As against this, the lump sum investment is a high risk, high return proposition. The risk is higher in investing a lump sum amount as the entire investment faces a downside risk if the market goes down. However, if the market goes up, the reward too is higher as the value of the entire investment appreciates.

An SIP works best in a bear phase when the market goes down and, as a result, the investor is able to bring down the cost of purchase, while the lump sum investor sees the value of his investment depreciate during the bear phase. On the other hand, the SIP investor is at a disadvantage as compared to a lump sum investor if the market goes up during the investment tenure. In this case, while the lump sum investor sees the value of his entire investment appreciate, the SIP investor keeps buying units at higher prices every time he pays the SIP instalment.

In short, starting an SIP during a bear phase works in favour of the SIP investor, while investing a lump sum amount during the bull phase works for the lump sum investor. The crucial factor is to identify the phase in which the market is in and then make the choice between SIP and lump sum investment.