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SIP, SWP and STP - what do they mean, which one should you choose and when?

This article demystifies some common jargons of investing in mutual funds by explaining SIP, SWP and STP along with examples of which one to use and when.

SIP, SWP and STP - what do they mean, which one should you choose and when?


Posted on 28 Aug 2022
Author: Sayan Sircar
6 mins read
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This article demystifies some common jargons of investing in mutual funds by explaining SIP, SWP and STP along with examples of which one to use and when.

SIP, SWP and STP - what do they mean, which one should you choose and when?

📚 Topics covered:

Defining SIP, SWP and STP

SIP SWP and STP

All of these are standing instructions that get executed as per a schedule you specify:

  • Systematic Investment Plan (SIP): Money from a bank account is invested into a mutual fund, typically once a month
  • Systematic Transfer Plan (SIP): Units from a mutual fund are redeemed to invest in another mutual fund of the same AMC
  • Systematic Withdrawal Plan (SWP): This is the reverse of the SIP. You sell the units from a mutual fund to send money to a bank account

Note: You don’t invest in a SIP; you invest via one since a SIP is a standing instruction. You invest in a mutual fund, or basket of stocks, via a SIP.

Portfolio view for all goals

In the image above, SIP runs from years 1-17, and SWP takes over after that. However, STP may happen anytime in between for rebalancing purposes. We will explain the use cases below.

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What is the purpose of SIP?

The asset management industry and every seller of mutual funds have one mantra that they want to drill into the head of the investor:

Start a SIP and never stop a SIP so that the SIP will create wealth

There is nothing inherently wrong with the statement above, so let us break it down.

Why invest as a SIP?

Most people get paid once a month via salary, so it makes sense to match investing with money coming in

The concept of the SIP originates from the idea of dollar-cost-averaging (DCA). DCA allows you to:

  • regularly invest whenever you have surplus
  • without considering the ups and downs in the market since market timing is not possible
  • leading to averaging your buy price since you buy more units when the market is down and buy less when the market goes up

Just having a SIP is not enough

You need to keep a few things in mind since just having a SIP will not help you reach your goals or create wealth.

Blind SIP will not create wealth

Since markets fluctuate unpredictably, you will not know the end value of the SIP after 5-10-20 years. Here is an example of a 15,000/month SIP run for 15 years. The SIP amount is increased by 5% every year. The chart shows ten possibilities assuming the average equity return is 11% post-tax and a risk of 15%. The results are:

  • maximum value: ₹ 166 lakhs
  • minimum value: ₹ 44 lakhs

You can tell that the “wealth” generated in these extreme cases is very different. The better alternative here is to apply the concept of goal-based investing instead of a simple SIP: I have started a 15k SIP. How much money will I have in 15 years?.

When to use STP?

The STP is a way to transfer money from one mutual fund to another slowly. There is, of course, capital gains tax since the first leg of STP is selling mutual fund units. STP works very well in cases where behaviourally, you do not wish to take action due to inertia, tax implication or fear of market levels.

Investing a lump sum

Many investors use STP to invest a large chunk of money, instead of a lump sum, via STP from a debt fund to an equity fund. For example, let us say you have 5 lakhs from a bonus much higher than the 50,000/month SIP. You invest the amount in a debt mutual fund and then start a 6-month STP to send the money into an equity fund.

Exiting a fund

There are many reasons why you would like to switch from one mutual fund to another: it is not performing well, being a typical example as part of a regular review process: Are you checking the performance of your funds regularly?. Having an STP in place allows you to overcome the inertia of not taking action.

Rebalancing amongst asset classes

Rebalancing allows you to systematically buy low and sell high

STP is an easy way to implement rebalancing since you can run a 3-6 month STP to exit from a mutual fund that has gone up in value into one that has not gone up that much.

Related:
This article explains what rebalancing is and why it is important.

What is the right way to use SWP?

An SWP instruction implements DCA in reverse to fund a recurring goal like college fees for your children or monthly expenses in retirement. When these costs increase due to inflation, adjust the SWP amount.

Paying fees for school or college

(click to open in a new tab)
Calculation of SIP amount for multiple goals

Once you have a corpus for your child’s school or college education, you can create a quarterly or monthly SWP to get money into your account to pay the fees.

Related: Case study: how this double income single kid family can perform DIY goal-based investment planning

Retirement expenses

You can follow the principle of goal-based investing in creating a solid retirement corpus like this: Low-stress retirement planning calculations: worked out example.

When you retire, you can simulate a salary by starting an SWP from your cash bucket. Read more about buckets in retirement here: How to plan for retirement using the bucket approach?.

In this article, we cover the concept of funding retirement expenses via SWP: What happens if you do an SWP from an index fund in retirement?.

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Next steps:

1. Email me with any questions.

2. Use our goal-based investing template to prepare a financial plan for yourself
OR
use this quick and fast online calculator to find out the SIP amount and asset allocation for your goals.

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This post titled SIP, SWP and STP - what do they mean, which one should you choose and when? first appeared on 28 Aug 2022 at https://arthgyaan.com


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