When it comes to investing your money, there are primarily two strategies you can use: lump sum investing and Rupee Cost Averaging (Commonly called as SIP). Both of these come with advantages and disadvantages. In this post, I will walk you through both, showing you why you might choose one over the other and ideally, help you to determine which method makes the most sense for you and your goals.
Both strategies are widely used in Personal Finance. Especially in Mutual Investments, Rupee Cost Averaging or SIPs (Systematic Investment Plans) has become a big model. Recently a study showed that soon the SIP investment will overtake the FII (Foreign Institutional Investor) investments. But you cannot underestimate the lump sum investments. Let’s discuss both in details in this 2 part post.
What Is Lump Sum Investing?
Lump sum investing is fairly straightforward. You have a chunk of money to invest and you invest all of it at once. So, if you have Rs 10,000 you want to invest in the stock market, you do it on a given day. In MF investment you just draw a cheque in scheme name and invest.
The advantage of lump sum investing is that you are sure to get into the market. You won’t be tempted to go out and buy things with the money, like a new car or smartphone instead of investing it.
The disadvantage of this method is that you might invest all of your money when the market is at a peak and end up spending some time, possibly years, waiting for the market to recover.
For example, imagine if you had invested the Rs 10,000 right before the markets crashed in 2008. You would have had to wait until 2011 at the earliest just to get back to your starting amount of Rs 10,000. To avoid the chance of this, you can elect to implement Rupee Cost Averaging instead.
What Is Rupee Cost Averaging?
Rupee cost averaging is simply taking your money and investing it over a period of time. Using the example from above, if you had Rs 10,000 to invest, you could use this strategy and invest Rs 1,000 per month for ten months. Or you could invest Rs 500 a month for 20 months. The amount you invest each month and duration is up to you. The question you might have is how does this strategy work exactly? Here is an example.
Example of Rupee Cost Averaging
For this example, I am going to use real-life data so I can’t fudge the numbers to make things work one way or the other. I am going to use the Birla Frontline Equity Fund (BFEF) as the investment choice. I am going to invest Rs 1,000 each month for 10 months on the first business day of each month.
I will use January 2, 2015 as my starting date (and invest Rs 1,000 each month through October) and then look at the ending value as of June 17, 2016 which is when I calculated the data for this example.
In the chart below, you will see the ending daily value for (BFEF) as well as how many units I was able to buy for Rs 1,000. I rounded the purchases to 4 decimal points as most mutual funds do.
After I make the final investment in October of 2015, I own a total of 53.9244 units.
Fast forward now to June 17, 2016 and we see that the BFEF closed at 191.94. By taking the number of shares I own and multiplying that by 191.94, my total investment is worth Rs 10,350.25. I ended up gaining Rs 350 by Rupee cost averaging.
Rupee Cost Averaging Versus Lump Sum Investing
If you are curious, you probably want to know what would have happened if I had just went ahead with lump sum investing instead. Here is what would have happened. I would have invested all Rs 10,000 into the BFEF on the first business day in January 2015 and owned 53.9957 shares as a result.
Fast forward to June 17, 2016 and my investment would be worth Rs 10,363.93. I gained Rs 363 by using the lump sum investing strategy. This strategy ended up earning me an additional Rs 15 compared to Rupee cost averaging.
So is Rupee cost averaging not worth it? Should you just use lump sum investing all of the time? The answer isn’t so simple.
Let’s cover this in Part 2 of the post. Till then share your experiences with RCA or SIPs.
