Investment Objectives & Advice

Time Diversification: Lump Sum vs In Parts

There is an ongoing debate for many years about investing in lump sum or in Parts over 6 to 12 months. I have met and heard people from both the camps and they have a pretty strong view on their own philosophy. Though in reality the answer always in between and depends on individual. Personal finance is always about personal choices and you should chose the option after understanding the options correctly vs just making decision based on perception. Today, I will try to put my perspective on the same topic but let us first understand the concept of XIRR, a method to calculate returns for intermittent investing in parts.

Rate of return is a simple concept, for a years if you invest INR 12,000 and after a year if you get INR 13,800 your rate of return is “(13800 / 12000) – 1” = 0.15 or 15%. Though if i invest the amount in a monthly fashion INR 1,000 every month, this creates a problem. In this scenario the money invested in first month stays invested for full 12 months and the money invested in second month stays invested for 11 months, similarly the money invested in 12th month stay invested for a month only. Therefore returns on each investments differ due to different period of investment.

Return on 1st installment = 1000 x 15% x 12/12 = 150; Return on 2nd installment = 1000 x 15% x 11/12 = 137.5; Return on 3rd installment = 1000 x 15% x 10/12 = 125; ..Return on 12th Installment = 1000 x 15% x 1/12 = 12.5. Overall Return = 150 + 137.5 + 125 + … + 12.5 = 860, So for same 15% return in this case the amount received will be INR 12,860. The absolute return here on overall investment is “(12860/12000)-1” = 0.072 or 7.2% but mathematically the true rate of return is 15%.

Now let’s come back to the original quest to understand “Should we invest lump sum or in Parts?”. To understand this, I ran the analysis on Nifty 50 TRI from Jan 2000 to Mar 2019 data. Case 1: when we invest INR 12,000 in one go and measured the returns over the first year, Case 2: when we invest INR 1,000 in 12 parts monthly and measure the returns after the first year in XIRR as well as Absolute terms. Why just 1st year returns, because after first year you will be 100% invested so any returns post that will be same in both scenario.

Lumpsum vs in Parts

If you look at the first two bars that the Lump sum returns as well as XIRR returns are having similar distribution in each buckets for example 35% times the returns of lump sum investing is in range of 0% – 20% and so is for in parts investing in terms of XIRR. Therefore, there is no major difference of investing in lump sum or in Parts if you compare on XIRR. Though when you look in terms of absolute the story is quite different, there is only 4% chance to get <-15% returns vs 10% chance in terms of lump sum investing. This comes at the cost of giving up upside potential of generating returns >50% in lump sum 10% chance vs 0% chance to get such absolute returns while investing in parts.

What it means is that if you are having a aggressive risk profile and you do not need downside protection, then yes please go ahead to invest lump sum. Or you are an expert investor who can predict the market more accurately by active investing, then you can invest in lump sum and avoid the downside by predicting the market movements. For all other investors who do not know about market moves and are prudent to avoid downside, It is always suggest to invest your lump sum money over 6-12 monthly parts.

Please note this do not highlight that you should not do SIPs or regular monthly investing. This analysis is to be used only for your large sums like your Bonuses or withdrawal from insurance policies, PPFs/EPFs etc where the investment amount is quite high vs your regular monthly saving. The analysis here is for 100% equity investing using Nifty so you can still think of lump sum investing in funds where fund manager keeps juggling between asset classes like Multi Asset fund or Balanced advantage funds.

Lastly invest in the method you like, just understand the consequences and be ready for results as the gain as well as loss will be yours. You will be sad if loose more money but you will also be sad when your returns will be lower than the returns of lump sum investing. What will make you less sad, should be the correct and first question for yourself to finally decide about lump sum or investing in parts. Just don’t avoid investing.

Happy Investing!!

Also Read, Benefits of Diversification.




Investment Objectives & Advice

Three Levers of Finance

“No amount of reading or memorizing will make you successful in life. It is the understanding and application of wise thought that counts.” – Bob Proctor

This is the one quote which should be imbibed in our education system and in our lives. We have read and studied so many theoretical concept but very few of us understand those concept and fewer applies them in their real life. The below formula is probably one of those, which is read by everyone but applied by very few. This is one of the basic foundation of managing the portfolio but still not understood by many.

Amount = Principal x ( 1 + Rate of return ) ^ (Period)

Before we analyse our three levers of finance principal, period & rate of interest, Lets understand the lens through which we will analyse these. When i read the book by Stephen R Covey “The 7 habits of highly effective people”, the one concept that stuck with me was the circle of influence vs circle of concern. For those of you, who have not heard of this concept, I will share the quick gist of the concept. Circle of Concern is the events, news, people which affects us and the circle of influence is the acts and responses which are in control of ours. To be highly effective, One need to focus on the circle of influence vs the concern to take the right decisions. With some effort, education and changes, we can increase the circle of influence.

Now coming back to our Formula of compound interest, We all wants to accumulate money to serve our needs but most of the time we fail to understand the variables which are in our control vs the one which are not. Most of the investors are always have been the search of the best rate of return. I will get quizzed often to suggest the best stock or best MF or best asset class but very few times on any other aspects. Believe it or not but no one can do it with 100% consistency, Even Warren Buffet agrees to the same (Link).

We often discard the power of principal in the game of investing. This is one lever which is completely or at least to a large extent in our control but still least talked about. If i assume the common working/ saving life of individual, it will be 25-30 years and at a fix rate of 8% the impact of Principal as a factor can be see from the example. Person A investing 1,000 INR per month for 25 years @8% interest rate will be able to accumulate 9.5 lacs but if he is able to increase his investment by mere 5% every year he will be able to accumulate 15.4 lacs. The small change in principal by 5% can help him garner 60% higher final amount, Isn’t it fantastic? So, Please be aware and ask how much should i invest as one of your main question or Try to increase your investment amount as and when possible.

In a similar manner we keep forgetting the power of period which has a compounding effect on our savings. For example, if person A stays invested for 25 years with 1,000 INR per month or 12000 per year @8% then his investment of total 3 Lacs will mature as 9.5 lacs. While Person B starts late after 10 years, To invest same 3 lacs, he invests 20000 per year @8% for 15 years to get the maturity amount of just 5.86 lacs. The value of investing for long period resulted in 60% extra corpus and required smaller regular outflow. Therefore, Please make sure you make the full use of your investing life and stay invested for the longest possible period.

Lastly, Yes our favorite topic of discussion and obsession with the rate of return. The beauty of investment is that you can keep it simple or complex depending on how you like, I wrote earlier that looking for best investment return is a futile effort (Link). We should aim for the minimum required return and work toward those by managing our portfolio (Link). If you are expecting the YoY return of 12-13% by investing in equity think again as they are neither promised nor consistent. But as you educate yourself and learn few things you can increase your circle of influence to generate better returns. for e.g. Investing for longer period in equity can help you reduce the risk of loss. In below chart you can see that for 1 year investment you return can be anywhere from -60% to +105% but as you continue to hold your investment to 3 or 5 years the chances of losses as well as exorbitant high returns reduces.

Nifty Return _ Duration of Inv.png

There are otherways to improve your chances to secure better returns which we will continue to discuss. Till than continue to focus on the other two levers as well instead of just staying obsessed with returns.

Happy Investing!