I had got a question from a client who had a lump sum to invest in equity mutual funds but was hesitant to invest it as a lump sum. He asked if it is better to invest it in a liquid fund and then set up monthly or weekly STP to invest into the equity fund. This got me thinking that the mutual funds industry has convinced small investors that SIP is better than lump sum. However, I had read that there is no such thing and actually lump sum is better than SIP. I wanted to back my advise to the client with so solid data. So I have set out to do this analysis.
Who is this analysis applicable?
This write up is applicable only to investors who have a lump sum to invest. They have identified the equity mutual fund to invest. However, they are unsure if they can invest it in one shot. What if the market crashes tomorrow? Will I repent my decision to invest the entire lump sum in one shot? This is not applicable for those investors who do not have a lump sum. They save monthly and invest into mutual funds monthly by setting up SIPs. They have nothing to gain from the below analysis.
Back testing using HDFC Index fund Nifty Direct Growth
To do the analysis, I have used Freefincal’s Rolling returns calculator Excel to download the Fund’s NAV data. The data is available from Jan 1, 2014 (HDFC Nifty fund was started on 1st Jan 2014) till date. I have used the entire data for this analysis. I have also downloaded the NAV data for HDFC Liquid fund Direct Growth.
STP: On the starting date, Rs. 10,000 is invested in HDFC index fund nifty Direct Growth and the Rs. 1,10,000 is invested in HDFC liquid Direct Growth. Every month, Rs. 10,000 is switched from the Liquid fund to Nifty fund. In the final instalment, as the liquid fund would have grown over the period of 11 months, the witch amount will be higher. Let us consider the below example STP on the 15th of each month starting 15th Dec 2018. If the date of investment is a holiday, it will be done on the following working day. At the end of 1 year, the total number of units purchased is 1194.132. As on 15th Nov 2019, the market value of the units is Rs. 1,31,344. The taxation of Liquid fund gains is not considered in this exercise.
Lump sum: The entire sum of Rs. 1,20,000 is used to purchase units on 17th Dec 2018 as per the NAV on that day. The number of units allotted were 1205.121. As on 15th Nov 2019, the Market value of the units is Rs. 1,32,552.
Back testing: This example STP and Lump sum investment was done for one set of dates and NAVs as on those dates. What if the STP was scheduled for 1 day after on the 16th of every month or the 17th of every month? Can we do the same tests for each and every date? Yes, we can do that. For this reason, I have downloaded the HDFC index fund nifty Growth direct till date. I have also downloaded the HDFC Liquid fund Growth Direct. Using this data, we can perform back testing to check whether STP can purchase more number of units. Or will lump sum purchase get us more number of units.
The exercise is to find out which method help us to buy more units for the same sum of money.
Here we find that 65% is in favour of Lumpsum which only 35% in favour of 6 month STP.
In this comparison, we find that 53% is in favour of the 3 month STP which 47% is in favour of Lump sum.
Conclusion: The results of back testing suggests that Lump sum investment is still the best way to invest. However, the back tests show
that STP over a 3-month period is also a good way to invest. Taxation of liquid fund gains have not been considered. This means for an investor in the highest tax bracket, there is little to choose between the two.
Disclaimer: The back test has been done for NAV data for specific mutual funds. One cannot generalize this to all mutual funds. The past data has no bearing to future mutual fund performance!