Most of you set up systematic investment plans (SIPs) from post-tax monthly income. But what if you have lumpsum money to invest? This could be annual bonus, a windfall gain, or proceeds from selling a capital asset such as land. Here, we compare lumpsum investing and rupee-cost averaging (RCA) and discuss the associated behavioural biases.
Moderating regret
Suppose you have lumpsum money of ₹10 lakh and decide to invest in equity. You are likely to invest in multiple exchange-traded funds (ETFs) and equity funds.
This supposed diversification is a behavioural way to moderate future regret. What if you invest in a single fund and it performs poorly? If you identify five funds to invest in, it is highly likely that will split the ₹10 lakh evenly among the five.
But you are still exposed to future regret. What if the stock market declines a week after you make the investments? You could have been allotted more units had you delayed your investments!
It is for this reason splitting your lumpsum money and investing across several months is behaviourally optimal. This process is called RCA because your objective is to average purchase (cost) price across time. Note, there is a subtle difference between RCA and SIP, though both involve systematic investing.
RCA involves a choice between lumpsum investing and spreading investments across time to average your costs. SIP typically involves investing systematically from post-tax monthly income. You are unlikely to invest in multiple funds if you do RCA, as you remove market timing from the investment decision.
But RCA exposes you to the temptation to spend today than invest for future (present bias). RCA is typically set up to invest your lumpsum amount over 6-8 months. You may be tempted to spend the money before the next investment date!
Conclusion
It is better to remove the element of market timing when you invest lumpsum amount to achieve your life goals. RCA is, therefore, behaviourally optimal. To avoid the temptation to spend the money, you can operate a separate savings account (call it a master investment account) to manage all your investment decisions.
All lumpsum moneys along with your monthly savings can be transferred to this master account from where SIPs on equity funds, ETFs and recurring deposits, and RCA can be set up.
(The author offers training programmes for individuals to manage their personal investments)