One of the often-asked questions in investing is to decide when to invest a sum of money. Whether you have R1,000 or R10 lakh to invest, the question is:
Should you invest all that money over time (STP, Rupee cost averaging, or as a Lump sum, now, immediately).
Lump Sum (LS): investing all of your available money at once. This means what we call SIP is just a LS investment done every month. This is because that is the only amount of money available with us for investing at that point in time.
Rupee Cost Averaging (STP): The act of investing all your available money over time. You can decide over what period of time it should be invested – most advisors suggest that the amount be invested over a period of 12 to 24 months.
When you buy periodically into the market (i.e. monthly SIP) you are actually making a small lump sum investment every time you buy.
With LS you invest R24,000 (all your funds) in the first month, but with STP you only invest R1,000 in the first month and hold the remaining R23,000 in cash (say Ultra-short fund or liquid fund) to be invested in equal-sized payments over the next 23 months.
If we know (or assume) that the assets you are investing in will increase in value over time – why not invest immediately? For example, you are a person doing a SIP of R 5,000 a month, and you get R. 500,000 inheritance from a relative (totally unexpected). Will you do a STP of R5,000 over the next 100 months? Your advisor will advise an installment of R40,000 per month over one year. The longer you wait, the worse off you will be, on average.
Risk of a Lump Sum Investment?
So, isn’t it riskier to do LS over RCA? The answer to this is a resounding “Yes!” Suppose you have R3 crore as the value of your portfolio. Now you have got R3 lakh to invest – will you invest it as a lump sum or as STP?
If your answer is ‘LS’ fine. If your answer is STP, my question to you is –will you sell your full portfolio, realize R3 crore and start doing a STP of R3,00,000 per month for the next 100 months? Why? Or Why not?
We have to think in terms of ‘total risk’ not just the risk of the current investments. If your portfolio is Rs 2 crore and you inherit Rs 23 crore as your share of an inheritance, things may be a bigger challenge.
Funnily, you are taking the same level of RISK. Nothing more, nothing less. An LS investment into a balanced fund with 65% in equity portfolio has the same level of risk as RCA into the Sensex over 24 months, yet the Lump Sum investment is more likely to outperform! You are just reallocating from debt to equity on a monthly basis, that is all.
So, if you are a disciplined investor who can RCA into a falling market while keeping your cash invested in Ultra Short bond fund/ Treasury Bills, then you might just be better off than doing a Lump Sum investment.
However, if you don’t know how you would react to a falling market, or you don’t have the discipline to move your cash to Treasury Bills, then please reconsider following a DCA(dollar cost average) strategy.
PV Subramanyam
writes at www.subramoney.com and has authored the best seller ‘Retire
Rich - Invest C40 a day’