Equity Mutual Funds

Lump sum Investment – how to invest lump sum amounts in Equity Mutual Funds

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It’s not about timing the market but time in the market

Haven’t we heard this market wisdom time and again! And while we completely agree with the underlying philosophy, what if we had the best of both the worlds – timing the market and time in the market?

And we will shortly see how.

Making lumpsum investments into equity mutual funds can be tricky. There are simply too many open-ended questions:

  • Should you invest everything in one go?
  • Or should you invest some amount (or nothing) and wait for markets to correct? What should be that amount? What if this time it’s different and there is no correction. And even if there is, when should you enter?
  • Or should you stagger your deployment systematically over some time? But what should that staggering be – 6 months or 12 months or 18 months?
  • Finally, what should be the portfolio allocation? Should it be a large-cap heavy portfolio? Or should you continue to play on the mid-cap euphoria in search for alpha returns?

These are pretty tough questions. And honestly, no one has any correct answers.

If only we had a crystal ball to help us predict the markets! But the unfortunate (actually…fortunate) truth is that no one can perfectly time the market.

But what we can do is to learn from history and use it to our advantage. Let’s see how.

A bit of historical perspective

Let’s first introduce the concept of Price-to-Earnings ratio (P/E) – one of the most widely uses metric to gauge market valuations (whether the market is expensive or inexpensive or fairly valued). In this article, we will use the P/E levels of Nifty 50 index derived by dividing the Nifty value by the profit of it’s underlying stocks (on a per share basis).You can read up more about P/E ratio here.

There are number of ways to calculate P/E ratios. Note that “P” is the current market price. But “E” can be interpreted differently. You can use 1-year forward EPS or 1 year trailing EPS. For the purpose of this analysis, we will use the official PE numbers published by NSE here.

P/E is just one of many valuation parameters. There are many more. But again, for the purpose of this analysis, we will just use P/E.

Now that we know what P/E is, let’s see 2 interesting charts that tells us the 3-year and 5-year returns (of Nifty 50 Index) at different NIFTY P/E levels

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sc2

Let’s understand these charts. Suppose we take a P/E band of 18 to 20 (x-axis of the charts). The dots in this band give you the returns (3-year and 5-year) that you would have earned if you invested on days when P/E was in the range of 18-20.

As you can see, for P/E levels greater than 25, the concentration of red dots (negative returns) increases. In fact, above 26, it’s mostly red.

Let’s simplify this further through a table:

P/E LevelsAverage 3 Year ReturnAverage 5 Year ReturnNumber of times negative return in 3 yearsNumber of times negative return in 5 years
Less than 1729.3%25.1%0.6%0.0%
17 - 2510.4%9.6%2.6%0.0%
Greater than 25-0.7%2.2%37.4%19.7%

Note: The return numbers are on NIFTY and data is from Jan 2001 till date

As you can see, at P/E levels above 25, even for a holding period as high as 5 years, you would have lost money 20% of times. Even your average 5-year return would have been just 2.2% as against overall average of 15.5%.

While the return numbers are based on assumption that you would have invested in NIFTY Index, directionally, it would be same even for an actively managed mutual fund.

The nifty P/E is precariously close to 25 (24.7 at the time of writing this article). And this is after a 8-9% correction that we have seen in past 2 months.

Given this context, we can clearly see that at current market levels, there is a decently high chance that if you invest today, you might end up with negative (or very low) returns even after 5 years.

To invest or not to invest – the lumpsum conundrum 

Given the historical perspective and today’s market levels, it is really a difficult decision for someone looking to invest a lumpsum amount. We have seen the open-ended questions at the beginning of this article.

Now if you plan to do (or are already doing) SIPs, you are pretty much covered. Any corrections going forward will only help you out with averaging. In fact, there is an even better way of doing SIP-like recurring investments. Check it out here.

But making a lumpsum investment is a whole different ball game.

And that is exactly why we call it a “lumpsum” conundrum.

What should you do if you are sitting on a lumpsum amount of cash and want to invest in equity mutual funds?

Don’t worry! We have you covered.

Our intelligent market-valuation linked dynamic investment plan (PE-DIP) is built specifically for people looking to invest lumpsum amounts in equity mutual funds.

PE-DIP is a set of algorithms that we have designed at Finpeg that we use to invest our client’s lump-sum amount. Our algorithms ensures an intelligent valuation-driven investment, redemption and rebalancing. This ensures that you get the most attractive entry as well as exit which in turn means much superior returns at significantly lower risk.

Do visit our website and if you like what you see, please do get in touch!

About the author

Shubham Satyarth

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