A lump sum investment is generally considered when the investor has a big corpus to invest. This could be money received after retirement or from the sale of a house or from an inheritance or it might just be the case that you have accumulated money in your bank account and wish to invest it now. There can be many reasons to consider a lump sum investment, but a SIP is generally recommended. This is more so in the case of investments in an equity mutual fund.
2. Benefits of SIP over Lumpsum Investments
A SIP has the following benefits over a lump sum investment:
a. No worry of timing the market
The markets have always been volatile. Investors often face confusion regarding the best time to enter the market. If you invest a big amount in a market high and the markets crash after you have invested, you will lose out on a major portion of your investment.
With a SIP, your money is spread over time and only some parts of your entire investment will be at a peak, which will allow you not only limit losses but also invest at a low with the next SIP installments
b. Rupee cost averaging
A SIP allows you to invest at different levels of the market. When the market is low, the fund manager will be able to buy more units as compared to when the market is at its peak. It will help to reduce the per-unit cost of buying the units. This phenomenon is known as rupee cost averaging. Ultimately, you will end up with higher gains.
c. Build the habit of investing
When you initiate a SIP, a fixed sum is transferred from your bank account to the mutual fund scheme. It is a disciplined way of investing and inculcates the habit of saving.
The earlier you start, the larger the corpus that you may accumulate.
d. Ideal for budding investors
If you are someone who has just started a career, then SIP is your thing. You can begin investing and get exposure to equities even with a nominal amount. As your income increases in future, you may step-up your investments.
SIP investments can also earn higher long-term returns as compared to lump sum investments. You can still invest a lump sum amount in a debt fund, but SIPs are the way to go when it comes to investing in equity funds.
3. How should you invest in mutual funds if you have a big corpus in hand?
Let’s suppose you have ₹10 lakh in your bank account that you wish to invest in mutual funds for the long-term. You should surely not put the entire amount in equity funds in one go.
There are two approaches that you can take to invest this amount:
a. Start a monthly SIP of an amount that you are comfortable with. This could be ₹10,000, ₹20,000 or ₹50,000. Let the money stay in your bank account till all of it gets invested systematically in the equity mutual funds you have chosen
b. Invest the lump sum in a liquid fund. Then start a Systematic Transfer Plan (STP) from the debt fund to an equity fund. Your corpus will not only earn higher returns than a savings bank account but also allow for systematic investment
If you want to go for an STP, then be aware of the tax implications.
4. What are the rules of taxation on the gains made from such investments?
Gains made from debt fund are subject to capital gains tax. Short-term gains are added to your taxable income while long-term gains are taxed at 20% after indexation. Every STP installment will be considered as a redemption from the debt fund and taxed accordingly. But despite the tax, the debt fund investments will generate higher returns than a bank account, especially if the STP to an equity fund runs for a long period of time. Investors who don’t want to complicate things can opt for the first option. But either way, a lump sum in an equity fund should be avoided.