Imagine two students preparing for an exam. The first student studies regularly throughout the year, finishing lessons in small manageable chunks. The second student studies only a few days before the exam, cramming in marathon study sessions.
The approach of the first student is steady and less risky. The student can achieve a decent score, even if he doesn’t study before the exam. On the other hand, the approach of the second student is highly risky. If things go according to plan, he may be able to get a decent score in the exam. On the other hand, if the student falls sick before the exam, he may fail to complete the lessons, and even end up failing.
In investing terminology, the approach of the first student can be equated with SIP investments, while the second student's approach is similar to lump-sum investments.
Differences between SIP and Lumpsum Investments
SIP (Systematic Investment Plan) involves investing small amounts of money, regularly over the long term. Generally, in a SIP plan, investments are made – weekly, monthly, bi-monthly, quarterly or annually. The amount invested is small and is fixed for every instalment.
On the other hand, in lump-sum investments, the entire investment amount is paid in one-shot at the beginning of the investment period. There are no further investments for the whole of the investment tenure.
Now, before we analyse which is the better option for ELSS investments, here’s a quick recap on the ELSS scheme.
What is ELSS?
ELSS (Equity Linked Savings Scheme) is one of the most popular tax-saving instruments. It’s a diversified mutual fund scheme that helps investors enjoy equity-linked returns as well as tax exemptions.
As per the old income tax regime, investments up to Rs. 1.5 lakhs are eligible for tax deduction under Section 80C of the ITA. This means if you have invested Rs. 1.5 lakhs in an ELSS plan in a fiscal year, you can deduct this amount from your taxable income. This reduces your overall taxable income, which, in turn, reduces the taxes you pay.
However, note that the maximum deduction available under Section 80C is 1.5 lakhs. This includes all other eligible tax-saving instruments like PPF, NPS and others.
Now, coming to the big question,
Which is better for ELSS investments? SIP or Lump-sum?
Let’s analyse both the methods under several factors.
The primary difference between these methods of investing is the varying levels of risk. Generally, SIP investments are considered less risky compared to lump-sum investments. This is because, in SIP, you spend only a fraction of your total investment at a particular time.
For instance, let’s assume that you wish to invest Rs. 1.5 lakhs in an ELSS plan to maximise your tax benefits. In SIP, you invest Rs. 12,500 every month, thereby spreading your risk evenly for the entire year.
On the other hand, in lump-sum mode, you invest the entire amount as a single instalment, thereby exposing your entire investments to the volatility of the market.
SIPs are ideal for investors who wish to reduce their risk exposure. Seasoned investors who have the skills required to time the market can go in for lump-sum investment.
Return on Investments
While it's true that lump-sum investments carry higher risk, they also offer the potential for generating higher returns, especially when the market conditions are favourable. On the other hand, if the market conditions are volatile, then the risk of losses are lower with SIPs.
Let's explain this clearly with an example. Consider two friends who decide to invest Rs. 1.5 lakhs in an ELSS mutual fund. Person A invests the entire amount as a single lump-sum payment, while Person B opts for the SIP route, paying Rs. 12,500 per month. At the time of beginning the investment, the NAV of the scheme is Rs. 10.
In this case, Person A’s investment of Rs. 1.5 lakhs purchases 15,000 units (1,50,000/10), while Person B is initially allotted 1250 units (12,500/10).
Now, consider the scenario that the market rises steadily over the year. This means Person B will receive lesser units every month for his investment of Rs. 12,500. At the end of the year, the average purchase price of Person B is higher than that of Person A, who purchased all his units at the NAV value of Rs. 10 at the beginning of the year. When the market rises steadily, lump-sum investments make a better choice.
Now, consider the opposite scenario. The market sees a steady downward movement throughout the year. In this case, Person B, who makes SIP investments, will be able to purchase more units at a lower NAV. When the market sees a downward trend, SIP investments emerge as the better choice.
However, the reality is that markets do not move uni-directionally for a long time, and they tend to rise and fall. In volatile markets, SIPs are the better choice as you purchase fewer units when prices are high and more units when rates are low—thereby bringing down the average purchase cost. This factor is known as Rupee Cost Averaging and works to the benefit of SIP investors.
Cash in Hand
The amount of money you have in hand for investing plays a crucial role in determining your preferred mode of investing. If you're a regular salaried individual, paying lump-sum out of pocket may not always be possible. In such cases, SIPs come to your rescue as you can regularly invest with small amounts.
On the other hand, if you receive a bulk sum from an inheritance or the sale of a property, you can opt for lump-sum investments, especially if the market conditions are favourable.
Benefits of SIPs for ELSS Investments
Easy to get started – you can start with a small amount as just Rs. 500 per month.
It teaches the habit of regular investing.
Hassle-free – you can set up ECS, and the amount will be withdrawn regularly from your bank account.
Ideal for first-time investors as you don’t have to worry about timing the market.
It doesn’t pose a burden on your monthly budget, as you set aside only a small amount every month for investment purposes.
Benefits of Lump Sum for ELSS Investments
If you're a business owner, you receive seasonal revenues, you can opt for lump-sum investments.
For tax-saving – if you have not invested in any tax-saving instruments under Section 80C all through the year, you can opt for last-minute lump-sum investments in ELSS to reduce your taxable income for the fiscal year.
Factors to Help you decide
You can opt for SIP investments if you have a limited budget and cannot may investments in bulk. On the other hand, if you have a large corpus available, then opt for lump-sum investments as it can help you save taxes.
SIPs are best suited for volatile markets as it averages the risks due to rupee cost averaging. On the other hand, lump-sum investments give higher returns in a steady market.
Additional Reading: ULIP vs ELSS: Which is the Better Investment Choice?
Which is the better method of investing? SIP or Lump-sum?
There is no fixed answer. It all depends on your finances – the availability of funds and the current volatility of the market. When it comes to returns, the differences are not much. So, make sure to choose the right method that works for you and start investing in ELSS funds.