Factors to consider before investing in mutual funds for lumpsum investment

In India, mutual funds have become an increasingly popular choice for investors to achieve their financial goals, both short term and long term. A mutual fund is a professionally managed investment vehicle that pools money from multiple investors to purchase a diversified portfolio of securities, such as stocks, bonds, or a combination of both, to meet specific investment objectives, such as wealth generation and capital preservation.

Among the various investment strategies, lumpsum mutual fund investment has gained traction because of the several benefits it provides. A lumpsum investment essentially involves investing a large sum of money at once. The advantage of doing this, as opposed to investing through the Systematic Investment Plan (SIP) route, is the scope for considerable capital appreciation within a fairly short period provided market conditions are favorable.

Before you make a lumpsum investment in a mutual fund of your choice, it is important to understand the way you should approach this investment strategy, as well as its various benefits and risks. Once you are aware of these factors, you can confidently make investment decisions for building a portfolio that is aligned with your financial goals and risk tolerance.

Lumpsum vs SIP investments in mutual funds

The SIP route is almost synonymous with mutual fund investments at this point and for good reason. SIPs allow you to access various markets with amounts as small as Rs. 100 to build your portfolio slowly over time with periodic payments. SIPs also offer the benefit of rupee-cost averaging, which eliminates the need to time the market. This means that even a person with little to no knowledge about the markets can start investing.

While SIPs involve regular investments of small amounts in a mutual fund scheme, a lumpsum investment means investing a large or significant sum of money at once in a fund. This requires one to be cognizant of the market conditions and timing, and to have some knowledge of the way the markets work. Lumpsum investments also require one to have certain idle funds that they can afford to invest and do not require in the short term.

Neither lumpsum nor SIP investments are superior to each other. The choice between them depends on how much money you have available to invest at a given time, your market knowledge, your financial goals and risk appetite, and your current investment strategy and portfolio structure. In what follows, let us take a look at the benefits on lumpsum investments.

Benefits of lumpsum investments in mutual funds

• Potential for higher returns

The possibility for better returns within a short period of time is one of the key benefits of lump-sum mutual fund investing. Because the entire amount is invested at once, the investment can potentially benefit from market movements.

If you have a large amount of money as an investible corpus, you could even benefit from market volatility by buying promising securities at discounted prices and then benefitting from the price recovery or increase over time. Hence, the potential for capital appreciation is higher with lumpsum investments if the market conditions are aligned.

Moreover, with lumpsum investments, the power of compounding is stronger because the longer your money remains invested, the greater is the scope for capital appreciation.

• Convenience and simplicity

Lumpsum investments offer the convenience of making a one-time investment. Once you have carefully chosen a mutual fund scheme that is aligned with your goals and risk tolerance, you can deploy all of your investible corpus in the chosen scheme at once. All you need to do then is review the performance of your scheme once every six months or so.

Whenever you have more investible funds, you can always choose to make another lumpsum investment in the same scheme if it has been performing well. This way, you don’t have to commit to any scheme on a monthly basis, which may be preferrable if you’re either unsure about the scheme’s performance or about what your income or expenses will look like in any given month.

This might allows you to optimally utilize and manage your funds. For instance, if you receive a bonus at work, instead of allowing it sit idle in your savings account, you can make a lumpsum investment in a mutual fund. Similarly, if during a specific month, you face certain unanticipated expenses, you do not have the obligation to invest in that month like you would if you were subscribed to an SIP.

Risks of lumpsum investments in mutual funds
1. Market risk

Lumpsum investments are susceptible to market risk or volatility risk. This means that if there is a market downturn, the value of your mutual fund holdings may decline because the value of its underlying securities may decline. Moreover, by nature, lumpsum investments are more vulnerable to market volatility than SIP investments, which are spread over time.

It is important to remember that this very market volatility is like a double-edged sword. While it brings with it a higher level of risk, it also creates a greater scope for significant capital appreciation. Hence, lumpsum investments in equity mutual funds can be high-risk, high-yield investments.

2. Timing risk

Lumpsum investments decisions are based on timing’ which if not optimal, can limit your your scope for capital appreciation. In the worst case, you may incur capital losses. Hence, as an investor going for lumpsum investments, you have to be abreast of the current market conditions and trends, and, accordingly, make an investment or delay it.

The requirement of timing the market when making a lumpsum investments in a mutual fund is invariably a risky proposition because it is extremely difficult to time the market perfectly, even for the most experienced of investors. Hence, lumpsum investments are better suited for investors who have a high risk tolerance, market knowledge, and experience.

3. Liquidity risk

While most mutual funds are liquid and do not have lock-in periods, they do carry liquidity risk, which is linked to capital or market risk. This is because of market volatility, which causes frequent price fluctuations. Say you suddenly need money to meet certain unanticipated expenses and you wish to liquidate your equity mutual fund investment. However, if the market is down, you will have to redeem your holdings at a loss.

The alternative here is to let your investment sit and recover over time, and find another source of money to meet the expenses. Therefore, it is essential to always have a solid emergency fund—an amount of money that can cover 6–12 months' worth of your living expenses—that is highly accessible and liquid so that you can fall back on it instead of having to sell your lumpsum mutual fund investments at a loss.

Situations when you should consider making lumpsum investments

In addition to considering the differences between lumpsum and SIP investments, as well as the benefits and risks of lumpsum investments, it is helpful to know certain situations in which lumpsum investments can be fruitful. Here are some of them:

• When you have a large sum of money available that you do not need any time soon for any other purpose. In this case, making a lumpsum investment in a mutual fund allows you to invest your idle funds at once and potentially benefit from market movements.
• When the market is expected to rise. At such a time, lumpsum investments may be fruitful because you can invest at a lower price and benefit from a potential market rally over time.
• When you have a short-term investment horizon. In this situation, lumpsum investments, especially in debt mutual funds, may be suitable for you. When you simply wish to park your savings or emergency fund, making a lumpsum investment in a debt fund like a liquid fund may be beneficial.
• When you come across an investment opportunity that may be time sensitive. For instance, making a lumpsum investment to buy the dip in a specific sector such as technology may help you to make the most out of that market condition.
• You have a high level of risk tolerance. In such a case, lumpsum investments could be suitable, especially in equity mutual funds, as they are more susceptible to market volatility. If you can assume a higher level of risk, your scope for capital appreciation may increase.

How to pick a mutual fund scheme for lumpsum investments?

Here are some points to remember when picking a scheme for a lumpsum investment:

• First and foremost, the scheme should be aligned with your financial goals, risk tolerance, and investment horizon. For instance, if your goal is to focus on capital appreciation over a long-term investment horizon and your risk tolerance is high, you should consider equity mutual fund schemes, such as multi-cap schemes and sectoral funds.
• Next, carefully review the mutual fund scheme’s past performance over one, three, and five years. While past performance is not an indicator of future yields, it can help you gage how the fund has performed across various market conditions.
• You would do well to look at certain important mutual fund ratios, such as the expense ratio, beta, and alpha. These figures will help you assess the cost of investing in a specific scheme, the scheme’s volatility relative to the broader market, and more.
• Finally, try to learn about the fund manager of the scheme and the experience they bring because they will play a key role in all the important investment decisions related to your fund holdings.

Wrapping up

Under favorable market conditions, lumpsum investments in mutual funds may offer the scope for capital appreciation. This is because the entire amount is invested at once in a mutual fund of your choice, and the investment may benefit from market movements and generate high yields, thereby potentially helping you meet your financial goals quicker.

Lumpsum investments also offer the convenience of making a one-time investment, which can be appealing if you have a large sum of money that is parked idly. Lumpsum investments in mutual funds provide greater flexibility because you can invest any amount you like at any time and exit the investment at any time. Unlike SIPs, there is no recurring commitment.

Another benefit of lumpsum investments in equity mutual funds is the potential for cost savings. Because lumpsum investments are made at once, you can avoid the transaction costs and other fees associated with making regular investments through an SIP.

While lumpsum investments offer several benefits, they also carry certain risks, such as market risk, timing risk, liquidity risk, concentration risk, and inflation risk. For this reason, it is crucial that you carefully evaluate your investment goals, risk tolerance, and investment horizon before making a lumpsum investment in a mutual fund scheme.

Moreover, it is important to note that your investment portfolio can benefit from both lumpsum and SIP mutual fund investments, and you do not have to choose only one of these investment modes. In fact, a solid investment portfolio is well-diversified in terms of the underlying investments and investment routes. Varying market conditions and personal finance situations will call for either lumpsum or SIP investments in mutual funds at different times. Therefore, it is essential to be flexible in your investment strategy and keep your eyes on the prize—your financial goals.

Source: Axismf Research
Note: Views and opinions contained herein are for information purposes only and should not be construed as investment advice/ recommendation to any party or solicitation to buy, sale or hold any security or to adopt any investment strategy. It does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. The recipient should exercise due caution and/ or seek professional advice before making any decision or entering into any financial obligation based on information, statement or opinion which is expressed herein.

Statutory Disclaimer: Axis Mutual Fund has been established as a Trust under the Indian Trusts Act, 1882, sponsored by Axis Bank Ltd. (liability restricted to Rs. 1 Lakh). Trustee: Axis Mutual Fund Trustee Ltd. Investment Manager: Axis Asset Management Co. Ltd. (the AMC). Risk Factors: Axis Bank Limited is not liable or responsible for any loss or shortfall resulting from the operation of the scheme. No representation or warranty is made as to the accuracy, completeness or fairness of the information and opinions contained herein. The AMC reserves the right to make modifications and alterations to this statement as may be required from time to time.

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.