Is SIP better than Lumpsum Investment?

NO SIP is not beneficial

If you think SIP has the power to allay your loses or protect you from volatility as promised by the mutual fund houses, Investment advisory, then brace yourself for a shock!

We get salary every month so we are forced to invest every month.

If you have 100Rs now its better to put 100 now in equity than divide it into monthly chunks and then put it in equity market

I Can prove it using Monte Carlo Simulation.

it is a tool by which we can simulate real world scenarios ,like how stock market can trend in future.

We will create 100 path and see the end result and check for ourself if SIP is the best choice or not.

We assume annual volatility of 12% ( which is the historical average) and risk free rate of 6.5% for simulation.

These are the various outcome we can have after 5 years.

Now let’s check in how many scenarios my average cost is less than 10000, i.e the cost if invested lumpsum today.

Below is the scatterplot of 100 simulations

Percentage cost less than 10000 = 23%

Min Cost = 7690

Max cost = 17880

Max benefit by averaging is far less while 77% time you are better off lumpsum.

Offcourse this is a simulated world and if we had a scenario where market is in depression for years and then goes up you will make profit but if we have such a pessimistic view of the market then why invest in the first place.

What I have done is a future scenario analysis. Infact we have backtested results of the US market.

Why does SIP lose to lumpsum. The logic is :

  1. By averaging you are betting that the market will drop, saving yourself some pain. For any given year the odds of this happening are less than 30%
  2. So statistically market is more likely to rise, in which case you will miss the upside. With each new invested portion you’ll be paying more for your shares.
  3. With SIP you are insinuating that market is too high to invest all at once thus you are trying to time the market
  4. By doing SIP you are changing the asset allocation as you will have huge cash position
  5. You will miss out on dividends
  6. Your cash will give around 4–5% return while you choose not to stay invested
  7. SIP also has time horizon. Since the market tends to rise over time, if you chose a long horizon (say, over a year) you increase the risk of paying more for your shares while you are investing. If you chose a shorter period of time, you reduce the value of using SIP in the first place.
  8. Finally, once you reach the end of your SIP period and are fully invested, you run the same risk of the market plunging the day after you are done.
  9. Backtesting shows in the long run lumpsum has outperformed SIP

What works for SIP is that it its psychologically easier and does not give you cold feet in a crash . You don’t have to fret over huge market drops , but with time when your investment becomes huge you will again have to deal with it.

So Rule 1) : If you want to put 100 Rs in equity better to put it now. You cant do it with your future cashflow but you can do it with your what you have.

Some people put everything in debt and then start a SIP which is not a good strategy.

Rule 2) If putting a lot in Equity makes you nervous then park money in something which has high yield like equity and less correlation.

Eg: P2P lending ,REIT etc.


Leave a Comment

Subscribe to the newsletter to get the latest information on Alternative Investments