Case 027Lump-sum allocationWarm up
A first-time investor inherits Rs 2 crore. Should it go into the market at once or in stages over a year, and what does a monthly transfer plan look like?
1The situation
Meenal Chitnis is 45 and teaches at a school in Nashik. She has never owned a mutual fund. Her father has left her Rs 2 crore, now sitting in a savings account. Her salary covers her spending, she has a separate emergency reserve, and she wants the money to support her retirement in about 15 years.
After a risk conversation you agree a target of half equity funds and half debt funds. For this case, assume an illustrative 11% a year expected from equity, 7.5% from debt funds and 6.5% from a liquid fund. These are planning assumptions, not forecasts.
2Your task
Do you invest the Rs 2 crore on day one or stage it over 12 months? If staged, lay out the plan, and put a number on what staging costs and what it buys.
Quick check
Staging over 12 months, rather than investing at once, mainly does what?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
For Meenal, stage it: park the Rs 2 crore in a liquid fund and move Rs 16.7 lakh a month into the half equity, half debt mix for 12 months. Investing at once has the higher expected return, and staging gives up about Rs 2.5 lakh of it. What staging buys is regret control: a first-month crash costs her Rs 1.7 lakh instead of Rs 20.0 lakh, and a first-time investor who panics once can lose far more than that.
Step 1Why does investing at once usually win on paper?
Think of a shopkeeper who has stock for the whole festival season but puts it on the shelf a little at a time. On average he sells less, because goods in the storeroom cannot sell. Markets rise more often than they fall, so money waiting in a liquid fund is, on average, money earning less than it could. With the transfers made at the start of each month, the average rupee waits 5.5 months. On Rs 1 crore of equity, the 4.5 point gap for 5.5 months is about Rs 2.1 lakh; the debt half adds Rs 0.5 lakh. Staging costs roughly Rs 2.5 lakh, about 1.3% of the money.
Step 2What does a monthly transfer plan look like?
Put the whole inheritance into a liquid fund of the same fund house and set a systematic transfer planAn instruction to move a fixed amount each month from one fund, usually a liquid fund, into another fund, so money is invested in steps without fresh paperwork each time. of Rs 16.7 lakh a month for 12 months. Each transfer is split into the target mix, so Rs 8.3 lakh a month goes into equity and the same into debt. By month 12 the liquid fund is empty and the portfolio sits at the agreed half and half, with no single day deciding her entry price.
Step 3What does staging buy that justifies the cost?
It buys protection against the one outcome that ends a first investor's plan: a sharp fall right after investing. If equity drops 20% in the first month, the lump sum loses Rs 20.0 lakh and the staged plan loses Rs 1.7 lakh. If the market falls 20% over six months and climbs back by month 12, the lump sum ends where it began, while the staged equity, bought partly at lower prices, is worth about Rs 1.12 crore on Rs 1 crore invested. Staging is insurance priced at about Rs 2.5 lakh.
Close with the reason this client gets the staged plan and another might not. For an experienced investor who will not sell in a fall, investing at once is the better default; for Meenal, the plan she will stick with beats the plan with the higher average. Twelve months is a judgement, not a rule: six to twelve is common, and stretching to three years mostly adds cost.
Where candidates lose it
Candidates claim that staging, or rupee cost averaging, earns a higher return. On average it does not, and an interviewer will push until the claim collapses. Say that investing at once wins on expected return and then argue for staging on behaviour.
The other miss is leaving the money in a savings account while it waits. The waiting money belongs in a liquid fund, with the transfers automated, so the plan does not depend on Meenal acting every month.
What the interviewer asks next
- Markets fall 15% in month three. Do you speed up the transfers, and what does Meenal need to agree to in advance for that?
- Would you stage the debt half at all?
- How would your answer change if Meenal were 70 and needed income from the money?
Company names and figures are illustrative.