To lump sum or to STP is the question?

To lump sum or to STP is the question?

When markets are close to new highs a lot of investors ask the same question.

I have some money in my bank account, should I invest it as a lumpsum or buy a liquid fund and setup a Systematic Transfer Plan (STP) into an equity fund over a year.

Over time two narratives have emerged:

1/ STP – why take the risk of investing at highs? The market will likely mean revert so averaging your buy price over a year is the way to go.

2/ Lumpsum – time in the market is all that matters. Since we cannot predict what the market will do (can go higher or lower), just invest as soon as you have the money.

The advisor community, by and large, has adopted that STP is the way to go.

We ran a backtest to see what historical data suggests.

We start with NIFTY index data going back to 1994. Over the past 24 years, the market has made a new all-time high in 48 months. In each of those months we set up two investments:

1/ Invest in a liquid fund and then STP into NIFTY over 1 year

2/ Invest in NIFTY

After 1 year we see which investment did better.
Times Outperformed Avg 1 Year Return
STP 19 8.7%
Lumpsum 29 12.0%
Total Instance 48

Of the 48 instances when we set up the STP vs Lumpsum race, lumpsum investment outperformed 60% of times. More importantly, investing in a lump sum in all 48 instances would have returned on average 12%, while a 1 year STP returned on average 8.7% after one year.

Lumpsum investing has outperformed STP even when market are making new highs. Lumpsum investments are likely to work out better 60% of times and with higher expected returns. 

The STP or lumpsum debate eventually is one of market timing. Doing an STP implicitly assumes that you can time a market high – it is the only scenario that justifies doing an STP over a lump sum. If you do not think you can time market highs, then don’t STP.

The narrative that data is telling us goes something like this –

Advisors recommend STP at market peak assuming that markets will correct. Future though is unpredictable and markets don’t correct as often as expected. Investor accumulates higher NAV through STP. Thus, investor STP returns are lower than Fund returns!

We ran the same analysis on S&P500 (from 1950) and NASDAQ (from 1971) and the results are the same. Lump sum outperforms roughly 3 out of 5 times and also on average has 2-3% higher 1-year returns.

So, next time someone asks – to lump sum or to STP, remember the data says to “lump sum”.

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This market update was initially published by CNBCTV18 in the Personal Finance section.

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