Lumpsum vs. Dollar Cost Averaging - DCA (Systematic Investment Plan - SIP)
TLDR: Which option is best - Investing in Lump sum or Dollar Cost Averaging - a Case Study
You are a star employee, you have worked your ass off for the last 12 months. You are exhausted by the long hours but you enjoy the challenge. It is that time of the year for your “Year end performance review”. You boss couldn’t be happier with all that you have accomplished and promises a big fat bonus (Let us assume you have a good boss who keeps his promise, I know it is a rarity but humour me for this example)
As promised the new year rolls around and you get a big fat check as a bonus. Given that you are a prudent investor you want to know what to do with this windfall. You want to invest this for the long term (greater than 7 years). So what do you do? Do you put the whole thing into the market as lumps or do an DCA (Dollar Cost Average) or RCA (Rupee Cost Average) via SIP (Systematic Investment Plan). Which option would give us the best results?
Case Study - Scenarios
I am going to use Reliance NIFTY ETF and Reliance NIFTY Jr ETF for this case study. They track largest 100 publicly traded companies in India via NIFTY and NIFTY Next 50 indices respectively.
Lump sum investment of 10 Lakhs (1 million) vs. SIP of 50,000 over 20 months
Best case scenarios for lump sum - end of subprime crisis
Worst case scenario for lump sum - start of subprime crisis
Middle of the ground scenario - 1-Jan-2006
Compare the results for different time horizons
I am going to ignore trading costs and expense ratios for the calculation
Scenario 1 - Best case scenario for lump sum - End of Subprime crisis
1-Jan-2009 - invest 10 Lakhs in lump sum and SIP of 50K each month over 20 months. What will be returns like at the end of 5, 7 and 10 years.
No surprises here. The Lump sum investor comes up on top by a big margin.
Scenario 2 - Worst case scenario for lump sum - peak of subprime before crash
1-Jan-2008 - invest 10 Lakhs in lump sum and SIP of 50K each month over 20 months. What will be returns like at the end of 5, 7 and 10 years.
Again no surprises here, The lump sum investor lags behind the SIP investor over 5,7 and 10 years.
Scenario 3 - Middle of the road conditions
1-Jan-2006 - invest 10 Lakhs in lump sum and SIP of 50K each month over 20 months. What will be returns like at the end of 5, 7 and 10 years.
This makes for an interesting case. When there has not been a major crisis and regular market condition, the lump sum investor comes up on top for all 5, 7 and 10 year time horizons and that too by a big margin.
How does NIFTY JR index compare ?
Scenario 4 - Best case scenario for lump sum - End of Subprime crisis
1-Jan-2009 - invest 10 Lakhs in lump sum and SIP of 50K each month over 20 months. What will be returns like at the end of 5, 7 and 10 years.
Stellar performance, from a fund with a CAGR of more than 22% over the last 10 years. You can expect nothing less.
Scenario 5 - Worst case scenario for lump sum - peak of subprime before crash
1-Jan-2008 - invest 10 Lakhs in lump sum and SIP of 50K each month over 20 months. What will be returns like at the end of 5, 7 and 10 years.
The difference is stark from the previous scenario. SIP beats down the lump sum investment in the worst case scenario.
Scenario 6 - Middle of the road conditions
1-Jan-2006 - invest 10 Lakhs in lump sum and SIP of 50K each month over 20 months. What will be returns like at the end of 5, 7 and 10 years.
Most of the time, the market is between the two extremes of boom and bust which is the middle of the road scenario. Here lump sum investment beats the SIP by a good margin.
Conclusion
Is there a conclusion here? I don’t think there is a clear winner and loser between lump sum investing and SIP based on the three types of scenarios. We picked two extremes - top of the market before crash and bottom of the market before the bull run. But the reality is that we can never predict the extremes so it is only useful as a theoretical backtesting mechanism.
For relatively conservative investors I would recommend going with an SIP preferably 18 to 24 month duration to spread the risk.
But for those who are aggressive, you could go for lump sum investment provided you are holding the asset for greater than 7 years. Historically lump sum investment has fared better than DCA as “Time in the market beats timing the market”. Some historical references from the US market below.
References
What your thoughts? Are you in the SIP fold or lump sum investment camp? Do you have specific examples where things have gone your way or you lost big time? Leave your comments below.