Investing an enormous sum from inheritance or property sale in lump sum can be a huge decision. But with a proper strategy, you can avoid unnecessary anxiety and losses, and prove rewarding in the long run. Lump sum investments are risky because of market fluctuations and various uncertainties which can reduce the value of your investments. However, experience shows that staying invested could be a smart decision instead of timing the market.
This strategy can help you wade through the temporary ups and downs in the market to provide better returns in the long run. Sudheer M, a Sebi-registered investment adviser, likens investing to nurturing a seed with care so that it can grow into a bountiful harvest.
Here we discuss key factors or a few options lump sum investors can consider.
Decide Your Need
Sudheer suggests that lump sum investments should be linked to a goal to help ascertain the tenure. When making a lump sum investment, he says two factors should be considered: investor's risk profile and investment duration. These factors are somewhat interconnected because the duration of your investment will decide the amount of risk you can take.
Brijesh Vappala, another Sebi-RIA says it is important to determine if the investor needs periodic income from the investment or if the growth can occur without providing for periodic income.
Strategy For Long-Term Need
It’s like planting a sapling that grows into a big tree. So if you’re thinking long-term and ready to take a bit more risk, a more aggressive strategy could be useful. In this approach, returns get primacy over safety because short term losses could be reversed into gains in the long run.
Says Sudheer, “For those with long-term goals and an aggressive risk profile, allocating a higher percentage of the investment into passive equity mutual funds, primarily index funds, is advisable.” He adds: “A smaller portion of the lump sum could be placed in relatively low-risk options like liquid or arbitrage funds.”
Passive funds are mutual funds that track market indices like Nifty 500 or Sensex 50, and investments are done in the same stocks that constitute the index. On the other hand, liquid funds are mutual funds that invest in safe, short-term instruments like Treasury Bills, Commercial Papers, etc. Arbitrage funds are mutual funds that primarily buy stocks at a lower price from one stock exchange and sell them at a higher price in a different exchange.
According to Brijesh, if the investor doesn’t require periodic income and if the requirement of money will arise after 5-7 years, then one can consider investing in long-term equity mutual funds. One could also consider debt gilt funds if he/she is risk averse, he says. Debt - Gilt funds have minimal default risk since they predominantly invest in bonds issued by central or state governments, the Reserve Bank of India or state government loans. However, they will fluctuate based on the interest rate movements in the economy.
“If the person has a need to get periodical income, he should stick to non-equity-based products. One could also consider fixed deposits with interest payout option, RBI or Govt bonds. Senior citizens may consider products like the Senior Citizens Savings Scheme,” Brijesh adds.
Strategy For Short-Term Need
Conversely, Sudheer says, a short-term goal would require a “flip over” of the above strategy. Here safety and liquidity is given primacy over returns. If you need your money back quickly, you must invest in safe instruments because you can’t wait around for a long time to get them back.
With primacy for liquidity and safety, Sudheer says that a larger share of lump sum should be invested in low-risk instruments like arbitrage funds and liquid fund. Sudheer also advises that a low-risk profile investor should also follow the reversed approach, with the majority invested in safer options. For such investors, investing in fixed deposits can also be considered if their tax bracket isn't high, he says.
Says Brijesh, “If the money is needed in 5-7 years, then investing in equity-based products should be avoided. For such purposes, a simple FD or money market funds may be suitable, especially for people in the lower tax bracket. People in the higher tax bracket could consider arbitrage funds, as they are more tax efficient, while having similar return and risk behaviour of short-term debt funds.”
In conclusion, it boils down to considering one's risk profile and investment goal duration as paramount factors in a lump sum investment.