Mutual Funds

Save Smart: SIP vs lump sum in debt mutual funds

Mahendra Jajoo | Updated on March 06, 2021

Contrary to popular belief, debt markets are also volatile, and entry points can impact returns

A systematic plan (SIP) is basically a concept of unit cost averaging across different phases of a market cycle. Thus it fits into any plan of investing regularly, and moderates the impact of market volatility. It offers protection from wrong timing of entry points.

While the general perception is that there is not much volatility in debt, let us just consider one data point. The gap between the highest and the lowest 10-year government bond yield in any given calendar year in the last 10 years has ranged from 48 basis points (bps) to 213 bps, with a median of 108 bps.

Thus, one can easily observe that debt markets also are volatile, and wrong entry points can impact returns.

Also, while debt is less volatile than equity, within debt funds, SIP has the potential to make an impact on medium- to long-duration debt fund categories on an incremental basis.


How to choose

The choice between SIP and lump sum is a function of how volatile the markets are during the intervening periods as also whether the returns are rear-ended, front-ended or evenly spread during these periods.

Typically, SIPs outperform lump-sum investments if the market performance is rear-ended, that is towards the end of the evaluation period. If the investor intends to lock-in the investment for a longer period of time, the impact of SIPs gets diluted, but still the potential of a value addition exists since it helps in averaging cost over time.

What is interesting to note, though, is that while SIPs may show a better average rate of return on investment, the absolute gain is still likely to be higher in lump-sum investments as more money is at work from the start, while in the case of SIPs, the money works in a phased manner.

So, SIP is a better option for those with a salaried income. But if there is a lump sum to be invested, just the fear of market volatility should not hold one back from going ahead.

SIPs in debt funds

SIP is more relevant in schemes where there is greater volatility, more so in the case of investments with a long time horizon of, say, more than three years.

In the case of debt mutual funds, generally speaking, gilt funds and dynamic bond funds with higher duration are considered more volatile than, say, banking and PSU funds.

Thus, intuitively, those are the funds where SIPs will likely have more impact than, say, in liquid funds where the maximum maturity of instruments is up to 91 days.

Investors with a periodic income and comparatively long-term outlook should invest via SIPs. It pays off well if the investor rides through an interest-rate cycle as it helps in cost-averaging.

As table 2 shows, the returns average out in the long run and there is a marginal difference in returns in a falling-rate scenario. However, the difference can be substantial in a rising-rate situation.Thus, SIPs can be effective for debt funds, too, especially so for long-term-oriented funds.

The writer is CIO - Fixed Income, Mirae Asset Investment Managers

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Published on March 06, 2021
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