Lump sum investment vs SIP when I have the lump sum

Question

I am fresh out of college and placed with a good job. It's been two months now and I have with me (after making all deductions):

• Two months salary
• Signing bonus = Equivalent to another 1.5 months of salary

I'm finally done setting up my bank, demat accounts and want to know what is the best way for me to organize / invest my money which includes:

1. Putting away the signing bonus worth money into a tax savings account over the next year)
2. Creating / maintaining an emergency fund equivalent to the signing bonus.

The options I currently have in mind are:

1. Put the signing bonus into the tax savings account (in lump sum); start a Systematic Investment Plan (SIP) for the remaining investments (and emergency fund) I have chosen.
2. Use the signing bonus as an emergency fund; start a SIP for both a tax savings account as well as other investments.

Please assume that the volumes chosen here (for an emergency fund, etc) are optimal. I have no debts, and a support system in place which because of which I can take higher risks.

Other options are also welcome. Thanks.

Answer 1

Vanguard released an analysis paper in 2013 titled "Dollar-cost averaging just means taking risk later." This paper explores the performance difference(s) between a dollar-cost averaging strategy and a lump sum strategy when you already possess the funds.

This paper is an excellent read but the conclusion from the executive summary is:

We conclude that if an investor expects such trends to continue, is satisfied with his or her target asset allocation, and is comfortable with the risk/return characteristics of each strategy, the prudent action is investing the lump sum immediately to gain exposure to the markets as soon as possible.

The caveat to the conclusion is weighing your emotions. If you are primarily concerned with minimizing the possibility of a loss then you should use a dollar cost averaging strategy with the understanding that, on a purely mathematical basis, the dollar cost averaging strategy is likely to under-perform a lump sum investment of the funds.

The paper explores a 10 year holding period with either:

• a 100% lump sum investment
• six to 36 month equal increment dollar cost averaging accumulation periods

The analysis includes various portfolio blends and is backtested against the United States, United Kingdom and Australian markets.

Based on this, as far as I'm concerned, the rule of thumb is invest the lump sum if you're going to invest at all.

Answer 2

Choosing between an emergency fund and investing aside, there is no reason to use a systematic investment plan when you have a lump sum ready to invest. Here are the three possible futures, and the effects on each strategy:

• The market goes up over time - if you use an SIP, you will lose out of the gains that you would have had if you invest now.
• The market is flat - there is no practical difference
• The market goes down - you will lose more if you invest now since your SIP purchases will buy more shares (relatively) after the market goes down.

Obviously if you are investing in the market you expect it to go up over time, so using an SIP will work against you in that case. If the market does go down you'd be better off, but historically the market has gone up more than it's gone down, so there's no practical reason to keep money in your pockets

You can always rebalance, change investments, do whatever after you've invested, so at worst you may have some transaction fees, but that shouldn't be a huge issue.

Answer 3

There is no right answer here, one has to make the choice himself.

Its best to have an emergency fund before you start to commit funds to other reasons.

The plan looks good. Keep following it and revise the plan often.

Answer 4

First, as Dheer mentioned above, there is no right answer as investment avenues for a person is dicteted by many subjective considerations. Given that below a few of my thoughts (strictly thoughts):

1) Have a plan for how much money you would need in next 5-7 years, one hint is, do you plan you buy a house, car, get married ... Try to project this requirement

2) Related to the above, if you have some idea on point 1, then it would be possible for you to determine how much you need to save now to achieve the above (possibly with a loan thrown in). It will also give you some indication as to where and how much of your current cash holding that you should invest now

3) From an investment perspective there are many instruments, some more risky some less. The exact mix of instruments that you should consider is based on many things, one among them is your risk apetite and fund requirement projections

4) Usually (not as a rule of thumb) the % of savings corresponding to your age should go into low risk investments and 100-the % into higher risk investment

5) You could talk to some professional invetment planners, all banks offer the service

Hope this helps, I reiterate as Dheer did, there is truely no right answer for your question all the answers would be rather contextual.

Answer 5

Between "fresh out of college" and "I have no debts, and a support system in place which because of which I can take higher risks." I would put every penny I could afford in the riskiest investment platform I was willing to. Holding onto money in a bank account is likely to cost you %1-%2 a year depending on what interest rates are and what inflation looks like. Money invested in a market could loose it all for you or you could become an overnight millionaire. Loosing it all would suck but you are young you will bounce back. Losing it slowly to inflation is just silly when you are young.

If there is something you know you have to do in the next few years start to save for it but otherwise use the fact that you are young and have a safety net to try to make money.