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In today’s era, mutual funds have become the most preferred and popular way to create a big and secure fund (Wealth Creation) from your hard-earned money. There are two most popular ways to invest in mutual funds – first is Systematic Investment Plan i.e. SIP and second is lump sum investment. Often there is a confusion in the minds of both new and experienced investors that if they do SIP of ₹ 5,000 every month or invest a lump sum of ₹ 1 lakh at one time, then by which formula they can achieve the big target of ₹ 20 lakh fastest. Let us understand the complete financial mathematics of both the investments in simple language.
What is SIP and how does its system work?
Systematic Investment Plan (SIP) is such a disciplined means of investing in mutual funds, in which you invest a fixed amount on every month, three months or weekly basis as per your convenience.
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Starting with small investment: For example, if you invest ₹5,000 every month, this amount is regularly deducted from your bank account and invested in the chosen mutual fund scheme.
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Rupee Cost Averaging: The biggest feature of SIP is that for this you do not have to wait for the collection of any bulk amount. Low income working people can also enter the market with their small monthly savings. This method helps in averaging out the ups and downs of the market.
What is lump sum investment and when is it beneficial?
Lumpsum investment simply means ‘lump sum investment’ i.e. when you invest your entire amount in a mutual fund scheme at once.
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Use of large sums of money: This method is considered most suitable for those people who have suddenly received a large amount of money from somewhere – like an annual bonus from the company, ancestral inheritance, money received from selling an old property or an old policy that has matured. In this, you do not have any obligation to deposit money every month, rather your entire invested amount keeps increasing over time due to compounding.
Complete calculation of monthly SIP of ₹5,000: When will you become ₹20 lakh?
If an investor starts a regular SIP of ₹5,000 every month and we consider a typical and average mutual fund investment on long term investment. 12% annual return Assuming this, the mathematics of the data will be something like this:
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Total investment period: around 13 to 14 years
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Total money out of your pocket: around ₹8,00,000
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Only interest earned through compounding: Approximately ₹12,00,000
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Total Estimated Fund at Maturity: close to ₹20,00,000
The magic of compounding: In this method, the investor invested only ₹ 8 lakh from his own pocket, while the remaining ₹ 12 lakh he got only through the power of compounding, which took his fund to the magical figure of ₹ 20 lakh.
Mathematics of lump sum investment of ₹ 1 lakh: When will it touch the figure of ₹ 20 lakh?
Now let us look at its other aspect. If a person invests a lump sum of ₹ 1 lakh in the beginning itself and invests it equally Annual return of 12% If you get it, the time taken for this money to become ₹20 lakh may surprise you:
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Total investment period: about 26 years
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Total money out of your pocket: ₹1,00,000
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Net Wealth Gain from Compounding: ₹19,00,000
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Total Estimated Fund: close to ₹20,00,000
Since in this method no additional money is added every month after the initial ₹ 1 lakh, the entire wealth growth depends only on the compounding return on the initial amount, due to which it takes double the time to reach the goal.
Which method will get you to your financial goals first?
This live financial comparison makes it clear that a monthly SIP of ₹5,000 can take you to a target of ₹20 lakh in just 13 to 14 years, whereas a lump sum investment of ₹1 lakh will take a full 26 years to reach the same target.
The biggest technical reason for this is that every month new money gets added to your original investment amount in SIP, due to which the total corpus of investment continuously becomes larger and the benefit of compounding on that larger corpus is also manifold. At the same time, in lumpsum investment, since the initial amount is small, it takes time for it to become big. However, if you have a large amount to invest in lump sum like ₹5 lakh or ₹10 lakh, lumpsum can yield faster results than SIP.
Always remember these 3 important things before starting investment
Mutual funds are subject to market risks, so discuss with your financial advisor and understand these basic rules before taking any investment decision:
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View at your convenience: If you have a regular monthly income and can save a little bit every month, then blindly choose the SIP route. If you have any huge amount lying in your bank account, it would be better to invest lump sum.
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No fixed return guarantee: Unlike traditional bank FD, returns in mutual funds are never fixed. The return of 12% shown here is only an estimate based on past performances, it may be slightly more or less depending on market movements.
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Alignment of goals and risks: Before investing money in the market, always note down these goals in your diary in advance – your total income, family needs, risk appetite and how long you can keep the money locked.