What is the difference between lumpsum and SIP?

What is the difference between lump sum and SIP?

Lumpsum investment, also known as a one-time investment, refers to investing your entire amount in one go. It is one of the most popular forms of investment in India. Systematic Investment Plan or SIP, on the other hand, is a mutual fund facility through which you can invest fixed amounts at regular intervals e.g. fortnightly, monthly, quarterly etc in a mutual fund scheme. Both lump sum and SIP investments are popular with retail investors. 

Lumpsum versus SIP calculators

Lumpsum and SIP are different types of investments. One should not compare the two. Lumpsum investments are subject to the availability of sufficient funds to make a one-time investment. In SIPs, you invest relatively small amounts at fixed investments (e.g. monthly) from your regular savings. Since lumpsum and SIP are different types of investments, we have other calculators for lump sum and SIP investments. In lumpsum, the entire investment earns returns from the day you made the investment. In SIPs, each SIP installment is invested for different tenures e.g. in a 10-year monthly SIP, the first installment is invested for 120 months, the second installment is invested for 119 months, the third installment is invested for 118 months, and so on so forth. However, both lumpsum & SIP calculator use the compounding effect. 

Compounding effect 

In mutual funds (growth option), the profits made by the scheme are re-invested in the scheme, just like how interest accrued is added to the principal in compound interest. Essentially, you earn a profit on profits by re-investing the profits. Over long investment horizons, the re-invested profits can be much larger than your initial investment. Your investment can grow exponentially over long investment tenures due to the power of compounding. 

How lumpsum calculator works?

Lumpsum calculators use the compounding principle to calculate returns or growth of an investment. Compounding is profits earned on profits re-invested; if profits are re-invested, then you get higher profits and higher returns over long investment horizons. The compounding formula used by the mutual fund lumpsum calculator is as follows (you can get this formula by transposing the terms of the CAGR equation):-

FV = I X (1 + r %) ⁿ

Where,
FV = Future Value of Investment
I = Investment Amount 
r = CAGR 
n = investment tenure in years

Suppose you invested Rs 5 lakhs in mutual fund schemes. Let us assume that the scheme will give 10% annualized returns. Corpus accumulated by you after 10 years will be = 5 X (1 + 10 %) ¹⁰ = 12.97 lakhs. 

How does SIP Calculator work?

A Systematic Investment Plan can be considered a series of lumpsum investments. So if you are doing a monthly SIP of Rs 10,000 for five years, you can think of it as 60 lumpsum investments of Rs 10,000 each. We can use the above lumpsum calculator to calculate the future value of each SIP installment, assuming 10% annualized returns. Please note that we are dividing the annualized returns by 12 because our investment tenure is in months now. 

• FV (1^st SIP installment) = I0,000 X (1 + (10% ÷ 12) ⁶⁰ = 16,453
• FV (2^nd SIP installment) = I0,000 X (1 + (10% ÷ 12) ⁵⁹ = 16,317
• FV (3^rd SIP installment) = I0,000 X (1 + (10% ÷ 12) ⁵⁸ = 16,182

In this way, the mutual fund SIP calculator will calculate the future values of all 60 SIP installments. Then accumulated corpus will be the sum of the future values of all the SIP installments.