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.
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.
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.
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.
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.
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:
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.
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)
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.
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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
