Invest Wisely: Combining SIP and Lump Sum for Financial Growth

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Introduction to SIP Plus Lump Sum Strategy

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A lot of smart investors use the SIP-plus-lump sum strategy for better returns. They maintain an ongoing SIP in mutual funds, and when markets fall, they invest a lump sum amount to benefit from market corrections. Recently, on June 4th, markets fell close to 6% following unexpected election results. On that day, many investors seized the opportunity to invest lump sums, aiming to capitalize on the correction.

But does this strategy work? We dug through data for an answer, and the results were surprising. We explored three key aspects: the type of correction, the size of the correction, and the optimal investment horizon to maximize returns with this strategy.

Key Assumptions for Analysis

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For an analysis like this, we need to consider multiple scenarios and assume a few things. The first assumption was the amount you can invest through a lump sum. Most people want to invest whenever the market corrects, but very few would be sitting on cash all the time. So, we made a few assumptions:

* The maximum amount you can invest through a lump sum annually equals your annual SIP amount.

* You make lump sum investments based on market corrections of 5%, 10%, or 15% from all-time highs.

* Investments are made at the first available opportunity.

Scenario Analysis: 5% Market Correction

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We analyzed Nifty Fifty data for the last fifteen years and identified periods when it was down 5% from its all-time high. We combined this with the normal SIP, and the results were surprising. If a person only invested through SIPs, they would make 13.78% returns. But using the SIP plus lump sum strategy, the returns were 13.77%. There was hardly any difference.

We looked at five random dates when lump sum investments were made. In some cases, the returns from lump sum investments were below the overall return of 13%. Therefore, buying on dips doesn't guarantee higher returns in the long term.

Scenario Analysis: 10% Market Correction

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We increased the market correction to 10%. The assumption was that a lower buying price should pull up SIP returns. We identified periods when the markets were trading 10% below their all-time high and did a lump sum investment of 40,000. The maximum number of investments in a year was reduced to three. The combined returns were 13.98%, only 20 points higher than SIP.

Scenario Analysis: 15% Market Correction

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We increased the size of corrections further and did the same exercise for a 15% correction. The number of investments in a year was reduced to two, and the investment amount increased to 60,000 per investment. Unfortunately, the difference in returns was not much. Normal SIP generated 13.78% returns while SIP plus lump sum generated 14.05% returns.

The data showed that increasing the size of market corrections was not very helpful in increasing returns.

Shorter Time Frame Analysis

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We changed our approach and analyzed shorter time frames. For a ten-year period, the simple SIP generated 14.86% returns. The returns improved to 15.10% with a 5% correction, 15.44% with a 10% correction, and 15.51% with a 15% correction.

In the case of a seven-year SIP, the simple SIP generated 16.37% returns. The returns improved to 16.96% with a 5% correction, 17.53% with a 10% correction, and 17.83% with a 15% correction. The strategy works well for shorter time frames, and higher market corrections yield higher returns.

Valuation-Based Investments

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We also analyzed what happens to returns if we invest a lump sum based on valuations instead of price corrections. We filtered out periods when the market traded below its historical valuations. We looked at the Nifty Fifty's PE ratio and compared it with its long-term median PE ratio since 2009.

For a ten-year period, the simple SIP generated 14.86% returns. The returns improved to 15.54% with a 5% valuation correction, 15.61% with a 10% valuation correction, and 15.97% with a 15% valuation correction.

For a seven-year period, the simple SIP generated 16.37% returns. The returns improved to 17.93% with a 10% valuation correction, and 18.70% with a 15% valuation correction. Valuation-based corrections did better than price corrections.

Key Takeaways

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There are two key takeaways from our analysis:

1. If your investment horizon is more than ten years, buying on dip strategy will do little to improve your overall SIP returns. Focus on maxing out your SIPs.

2. If your time horizon is less than ten years, you can use this strategy to improve your overall SIP returns. Making lump sum investments based on a 10% to 15% price or valuation correction has historically improved SIP returns by 100 to 250 basis points.

The only drawback with this strategy is the effort it requires. You need to track the index regularly. If that's not possible, simply max out your SIPs. Sticking to simple SIPs will probably not cost you much.

Conclusion

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In conclusion, the SIP plus lump sum strategy can be effective, but its success depends on various factors like the size of correction and investment horizon. For long-term investors, maximizing SIPs is key. For shorter horizons, combining SIPs with strategic lump sum investments can yield better returns.

Mutual fund investments are subject to market risks. Read all scheme-related documents carefully.

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