Understand the three important terms in the context of mutual fund investing and how to use them
21-Jun-2022 •Ravi Banagere
Mutual funds are widely known for simplifying the process of equity investing. They not only absolve you of the task of stock selection but also offer some great facilities that make you stay systematic and disciplined with your investments. Using these methods also helps you reduce the risk that comes with stock market volatility. Let's look at these three systematic methods in detail to understand their purposes and how you can use them to your advantage.
1. Systematic Investment Plan (SIP)
SIPs are a method of investing a fixed amount of money in a mutual fund at a regular interval, say monthly. This fixed amount can be as low as Rs 500. Thus, you can use it to invest small amounts of money over time to build a corpus. Also, spreading out investments over a period of time helps investors average their purchase cost and prevent them from committing all their money at a market peak. Through SIPs, investors become disciplined, thus making investing a habit.
Many people, despite knowing the importance of equity investing for wealth creation, keep sitting on the sidelines. They often cite reasons like, "the equity markets are too high", "the equity markets are down in the dumps'' or "the equity markets are going nowhere". Precisely, this is where systematic investment through an SIP comes into play. It helps you stay invested through the ups and downs of the market as you get rid of the dilemma of figuring out when to invest. Here, you simply invest a fixed amount on a monthly basis irrespective of what is happening in the stock market. For example, you can instruct the fund house to invest say Rs 10,000 on the 10th of every month for the next 60 months in a specific fund. Also, check out why SIP scores over lumpsum investment, i.e., putting all your money in one shot.
2. Systematic Transfer Plan (STP)
Just like an SIP, STP lets you invest in a staggered manner. The difference is that while in an SIP, the instalment amount moves from your bank account to the chosen fund. But in an STP, you make a one-time investment in a fund (mostly a debt scheme) and mandate the fund house to transfer a fixed amount from this scheme to another mutual fund scheme (mostly an equity fund) at a predefined frequency. For example, let's say you have some idle amount of Rs 10 lakh with you and you wish to invest it in mutual funds. You can invest this money in a fund and instruct the fund house to transfer Rs 50,000 from this fund to another fund on the 10th of every month for the next 20 months.
You might be wondering why one would go for an STP? Well, there are some use cases where doing an STP can be helpful. If someone has a huge lumpsum amount to invest, keeping it in a savings bank account can hurt the returns till the time it is fully deployed in an equity fund through an SIP. Since debt funds provide better returns than a normal savings bank account, STP helps you earn a little extra on the lumpsum while it is being invested fully in your desired scheme. Also, people who don't have the required discipline and are afraid they'll end up spending the corpus lying in the bank account, it may be a good idea to earmark this amount in a debt fund meanwhile and set up an STP from there.
3. Systematic Withdrawal Plan (SWP)
Smart investing is not only about entering the market systematically in order to beat volatility but it is also about having an exit plan in order to protect your corpus from any abrupt market fall just when you need it. So ideally, you should start withdrawing gradually from your equity mutual fund investments over a period of time before you need the money. SWP takes care of this need by allowing you to withdraw a specific sum of money from a fund at regular intervals. You can think of it as the exact reverse of an SIP. Therefore, in an SWP, a specific sum of money can be automatically redeemed from your mutual fund investments on a specified date every month and credited to your bank account. Alternatively, you may also move the money to debt funds with the help of systematic transfer plans (STPs) if your goal for which you need the money is still a bit far.
Just as SIPs help you average your investment costs, SWPs help you average your withdrawal. This ensures that you don't sell out at the bottom.