If you have come this far in learning about mutual funds, you have probably heard of 'SIP'. You may even have heard of its close cousins, the STP and the SWP. These are not funds or fund companies, but ways of investing in funds.
Here's a simple explanation of what these S_Ps are, and how they can benefit you.
Systematic Investment Plan (SIP): An SIP is a regular investment in a fund of a fixed amount at a fixed frequency. Generally, the frequency is monthly. SIPs neatly solve the two main problems that prevent investors from getting the best possible returns from mutual funds.
Firstly, since SIPs mean investing with a fixed sum regularly regardless of the NAV or market level, investors automatically buy more units when the markets are low. This results in a lower average price, which translates to higher returns.
If you invest a large sum at one go, you could end up catching a high point of the equity markets. This would mean that you have invested at a high NAV and that would reduce your gains if the market falls. An SIP is a good way to invest at an average price over a period.
Secondly, SIPs are also a great psychological help while investing. Investors inevitably try to time the market. When the market falls, they sell and they don't invest any more. When it rises, they invest more. This is the opposite of what should be done. An SIP puts an end to all this by automating the process of investing regularly. It eliminates the mental load of deciding when to invest and leads to better returns.
Systematic Withdrawal Plan (SWP): SWPs are a regular redemption from a fund. There are a number of variations. Investors can either redeem a fixed amount, a fixed number of units or all returns above a certain base level. Among other things, they are a convenient way to take a regular income from a fund investment.
Systematic Transfer Plan (STP): An STP is a regular transfer from one fund to another. It's like an SIP but the source of the money is an STP from another fund. The most frequent use of an STP is when you have a lump sum to invest in an equity fund. For reasons listed above, it is always better to invest gradually through an SIP rather than with a large sum all at once. In such cases, you could put the lump sum in a debt fund of an AMC and simply give instructions to transfer a fixed amount into a chosen equity fund every month. This is called STP.
Questions
- On what types of funds can one do an SIP?
- All equity funds
- Funds for which special SIP plans have been launched
- All funds
- In an SIP one will get better returns than lump sum:
- Always
- Sometimes
- Most of the times
- Along with better returns, one great advantage of SIP investing is:
- Better choice of funds available
- Lower tax on returns
- Habit of regular investing, without temptation to time the market
- An STP is an excellent way to invest when
- You have a lump sum that you want to invest in an equity fund
- You have a lump sum that you want to invest in a debt fund
- You have a regular income
This article was originally published on February 18, 2015.
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