Investing in ELSS Mutual Funds: Which is better Lump Sum or SIP

Equity Linked Savings Schemes (ELSS) is one of the best tax saving investment options under Section 80C. ELSS not only has the potential to give the highest returns, but it also enjoys advantages in terms of liquidity and tax efficiency over other 80C investment options - ELSS is simply the best investment for tax savings and wealth creation. As such, investors, especially if they are young, should always consider including ELSS as part of their tax planning investments. One question that investors often have about ELSS investments, is whether Systematic Investment Plan (SIP) a better investment mode than Lump Sum? While this question applies to all mutual fund investments, for many investors the question is more relevant for ELSS investments, because they are committed to make ELSS investments every year to get tax deduction of up to र 1.5 lacs under Section 80C. In my experience, most financial advisors and a large number of investors prefer investing in ELSS through SIPs. But some investors prefer lump sum investment. The obvious benefit of SIP is that it helps investors to average the rupee cost of a unit and thereby helps the investor to earn higher returns in the long term. On the other hand, some market savvy investors who prefer lump sum investments, reject the argument in favour of SIP on the premise that, while some units are a purchased at a lower cost through SIP, other units are purchased at a higher cost. Both arguments are true. Comparing SIPs and lump sum investment is, in my opinion, like comparing apples and oranges. In this article, we will compare lump sum and SIP modes, especially from the perspective of investing in ELSS funds.

Lump Sum investments versus Systematic Investment Plan returns

Do SIPs give better returns than lump sum investments? It depends on the market conditions. If the volatility is high in the market, SIP will give better return than lump sum because you can buy units at a lower cost. On the other hand, if volatility is low in the market, SIPs will give lower returns than lump sum investments, because you will be buying units at a higher price. The chart below shows the price movement of BSE Sensex from October 2004 to October 2007.

From October 2004 to October 2007 Sensex rose from 6,000 levels to nearly 18,000 levels. Though the market saw a few intermittent bull market corrections, volatility was low relatively speaking. If the broader market mirrored the Sensex trend during that period than lump sum returns would have been higher than SIP returns.

Let us now see the price movement of BSE Sensex during a period when market conditions were more volatile. The chart below shows the price movement of BSE Sensex from October 2012 to October 2015.

If you compare this chart with the 2004 to 2007 Sensex chart, you will observe that the Sensex has been much more volatile in this period. Consequently, SIP returns would be higher than lump sum returns during this period. If you compare lump sum returns with SIP returns of most ELSS funds, as well as diversified equity funds, you will see that SIP returns would have been higher than lump sum returns (please refer to our MF research section).

Comparison of absolute returns between lump sum and SIP

We will understand with the help of an example, the difference in absolute returns of lump sum investment and SIP. Let us assume Investor X invested र 1 lac lump sum in an ELSS fund 3 years back. Investor Y started a monthly SIP of र 3,000 in the same ELSS fund. Over 3 years Investor Y would have invested र 1.08 lacs on a cumulative basis. Investor Y’s cumulative investment through SIP is slightly higher than Investor X’s lump sum investment. Let us further assume over the 3 year period, the ELSS fund gave an annualized return of 25% (applicable for lump sum investments) and the monthly SIP returns of the fund over the same period was 30%. The SIP returns would have been higher than lump sum return on account of market volatility. Let us now see the current value of Investor X and Y’s investment.

We can see that even though SIP returns were higher than lump sum returns on an annualized basis, in terms of absolute returns, Mr X’s lump sum investment got much higher returns than Mr Y’s SIP, even though Mr Y invested slightly more on a cumulative basis. Does this mean lump sum investment is better than SIP? No, it does not. Lump sum and SIP are just different investment types. Therefore, one should not compare absolute returns of lump sum and SIPs. The reason why Investor X’s absolute return is higher than Investor Y’s is quite obvious. Investor X’s र 1 lac investment was invested for the entire period of 3 years. However, Investor Y’s total investment was not completely invested for the entire period, since the money was getting invested in small monthly instalments of र 3,000 over the period of 3 years.

Should you invest in ELSS through Lump Sum or SIP

• If you depend on regular monthly savings for your ELSS investments, it makes sense to invest through the systematic investment plan (SIP) route.


• If the investor has sufficient funds for their 80C investments for the year in April itself, they should invest in lump sum, unless they expect the market to be volatile during the year.


• If you have the funds to invest, but expect the market to be volatile, you should not keep your funds in a bank account and invest it over a period of time through SIPs. Instead you should invest your funds in a liquid fund and transfer it to the ELSS fund through a Systematic Transfer Plan. The returns earned on your liquid fund investment will be higher than that of your savings bank interest. Therefore, you will be able to buy more units of ELSS through the STP route than the SIP from your savings bank, assuming you have the funds available at the beginning of the year. How will you know, if the market will be volatile? Predicting what the market will do is almost impossible or at the very least, extremely difficult. Just because the market is volatile for a couple of months, it does not mean it will continue to be volatile. You should follow macro-economic and political trends affecting the markets, both global and domestic, and then make a determination accordingly.


• One thing you should always avoid in volatile markets is trying to find the market bottom. Even expert investors fail to time the markets, more often than we would tend to believe. SIPs or STPs from liquid fund to ELSS are the best mode of investments in volatile markets.


• If you are salaried or have a predictable monthly income SIP mode of investment is more suitable for you. If you are a business owner and your income is seasonal, you can opt for lump sum investment or a combination of lump sum and SIP, based on your monthly cash-flows.


• SIPs enforce financial discipline without any effort. Here are examples of problems faced by investors due to the lack of financial discipline.


• I have seen many investors scrambling at the last minute to make their 80C investment. Apart from the stress related to the last minute tension involved in the last minute scrambling, investors lose out returns they would have earned if they were investing through monthly SIPs throughout the year.


• I have also seen a few investors, missing their 80C investment deadline of Mar 31. As a result, they have to pay higher taxes which otherwise is completely avoidable, not to mention the loss of returns.


• Many companies have an internal deadline of late January, mid February or late February for their employees to submit their 80C investment proofs for TDS purposes. If the employees fail to furnish the proofs before the company deadline, higher TDS will be deducted by the company and then the employees will have to go through the inconvenience of claiming income tax refund in their income tax returns.


• Lack of financial discipline may also cause investors to spend the savings that they should have invested for tax planning. This results in investors paying higher taxes, not to mention the loss of future returns.


• Tax planning investments are something that a taxpayer has to make every year. SIPs are advantageous in that respect. If you select a good ELSS fund and start a monthly SIP based on your tax planning requirements, you can take care of your tax planning investments, at the least the portion related to ELSS, with a small one-time effort.


• Finally, if you have to make ELSS investments every year for tax saving, over a long investment horizon, the difference in returns between lump sum investment and SIPs will be, in most cases, not be very significant.

ELSS Investments through Systematic Investment Plans

ELSS investments have a lock in period of 3 years. If you are investing in ELSS through systematic investment plans, you should note that each SIP instalment will be locked in for three years from the date of the instalment. For example, if you started a monthly SIP in an ELSS fund in 2010, all the units bought with SIP instalments before November 2012, are available for redemption. However, units bought with SIP instalments after November 2012 are still in their lock in period and will be available for redemption only after each instalment completes 3 years. You should factor this in your financial cash flow planning.

Conclusion

In this article, we discussed lump sum versus SIP mode of investing for ELSS. The decision to invest in lump sum or through SIP depends on your personal financial situation and other factors discussed in this blog. Since tax saving investments need to made every financial year, the difference in returns between lump sum and SIP modes of investment is lesser for ELSS. Tax saving is just one aspect of 80C investments; wealth creation should also be an equally important objective, especially for young investors - ELSS is one of the best retirement planning investments for young investors. Whether you are investing in lump sum or SIP, the key to investment success is to choose the right investment and to remain invested for a sufficiently long time horizon, so that you can benefit from the power of compounding.