Mutual funds have become a go-to investment option for many looking to build wealth. They offer diversification i.e., spreading your risk across different investments, professional management of your funds, and the potential for greater returns than you’d likely see in a traditional savings account. However, the world of mutual funds can feel overwhelming, especially with various investment strategies to choose from.
This article explores four key concepts: Systematic Investment Plan (SIP), Systematic Transfer Plan (STP), Systematic Withdrawal Plan (SWP), and Lumpsum investment in Mutual Funds, explaining each with practical examples.
Systematic Investment Plan (SIP)
SIP is the most popular strategy in mutual funds where you invest a fixed amount regularly (typically monthly) in a mutual fund scheme. Think of it as a recurring deposit, but instead of going to a savings account, your money is invested in market-linked mutual fund schemes.
Key Features of SIP
- The Magic of Rupee Cost Averaging: By investing regularly, you naturally buy more when prices are down and less when they’re up. Over time, this helps to even out your average cost over time, so market fluctuations do not impact you significantly.
- Building a Disciplined Habit: SIPs encourage a consistent approach to investing, helping you build a strong financial foundation.
- Set it and Forget it: SIPs can be automated, making investing effortless. Once you’ve set up your SIP, you don’t have to worry about manually transferring funds or remembering to invest each month.
- Flexibility: You don’t need a lot of money to get started; many SIPs allow you to invest as little as Rs. 500 per month.
How SIP Works
Assume you invest Rs. 10,000 every month in a mutual fund via SIP. Here’s how it works:
| Month | Investment (Rs.) | NAV | Units Purchased |
| 1 | 10,000 | 100 | 100 |
| 2 | 10,000 | 83 | 120.4 |
| 3 | 10,000 | 92 | 108.7 |
| 4 | 10,000 | 110 | 90.9 |
| Total | 40,000 | 420 |
By investing Rs.40,000 consistently over four months, you’ve acquired 420 units. This means your average purchase price per unit is Rs. 95.23 (calculated as Rs.40,000 divided by 420 units). This average cost can be different from the average NAV of Rs. 96.25, which highlights the benefit of rupee cost averaging.
If you had invested a lumpsum of Rs. 40,000 in the first month, you would have only purchased 400 units.
This simple example illustrates how rupee cost averaging can lead to a lower average cost per unit compared to a lumpsum investment, particularly in volatile markets.
Who Should Opt for SIP?
Choose SIP when:
- You earn regular income
- You’re building an investment habit
- You want to invest smaller amounts
- You’re planning for long-term goals
- You want to average out market risks
Systematic Transfer Plan (STP)
An STP is like a pre-arranged plan to transfer a certain amount of money from one of your mutual funds to another at regular intervals, like monthly or quarterly. A common use is gradually shifting money from a lower-risk debt fund to a higher-risk equity fund. It’s essentially a combination of a systematic withdrawal from one fund and a systematic investment in another.
Key Features of STP
- Managing Risk: By gradually moving into higher-risk investments i.e., equity, you avoid the risk of putting a large sum in at a market peak.
- Flexibility: You can decide the amount you need to transfer and can modify or stop as needed. You can make customization as per your financial needs and goals.
- Stability: During periods of significant stock market volatility, you can gradually move your funds into safer investment options, such as debt funds and money market instruments. By transferring funds systematically, you can minimize exposure to market fluctuations and ensure that your investments are safeguarded during uncertain times.
Different types of STPs:
- Fixed STP: A specific/fixed amount is moved from one mutual fund to another at set intervals.
- Capital Appreciation STP: Only the appreciated value (profits) of the original investment is moved.
- Flexi STP: The amount you transfer from one fund to another isn’t fixed; it changes depending on the market conditions.
How STP Works
Suppose you have Rs. 1,00,000 to invest. Instead of investing directly in equity funds, you opt for an STP:
Initial Investment: Rs. 1,00,000 in a liquid fund
Set up monthly transfer: Rs. 10,000 from liquid fund to equity fund
Duration: 12 months
Month 1:
Liquid Fund Balance: Rs. 1,00,000
Transfer Amount: Rs. 10,000
Remaining in Liquid Fund: Rs. 90,000
Amount in Equity Fund: Rs. 10,000
Month 2:
Liquid Fund Balance: Rs. 90,000 + Interest
Transfer Amount: Rs. 10,000
And so on…
This strategy ensures that your money is gradually exposed to equity markets, thereby minimising timing risks.
Who Should Opt for STP?
Choose STP when:
- You have a large sum to invest
- You want to avoid timing risk
- You need flexibility in transfer amounts
- You want to earn returns on waiting funds
- You’re gradually shifting between fund types
Systematic Withdrawal Plan (SWP)
If you want to receive regular payment from your mutual fund options, SWP is an ideal choice. The SWP option provides a way to create a consistent income stream by withdrawing a predetermined amount at set intervals. This facility is particularly beneficial for your retirement to get regular income during those years.
Key Features of SWP
- Control and Flexibility: You have control over the details of your withdrawals with an SWP. You can pick the amount, the frequency (like every month or every three months), and the specific date that works best for you. You’re also free to stop your SWP or add further investments whenever you deem necessary.
- Regular Income: SWPs provide a regular cash flow, much like a pension.
- Compounding Benefits: When you set up withdrawals from your investment, you’re only taking out a portion. The rest of your money stays invested and continues to grow, potentially giving you more returns over time.
How SWP Works
Let’s understand with a scenario,
Rahul has retired and has Rs. 500,000 invested in a balanced mutual fund. He wants to generate a monthly income of Rs.10,000 to supplement his retirement funds. He decides to set up a SWP.
Here’s how it plays out over a few months:
Month 1:
Initial Investment: Rs.500,000
NAV (Net Asset Value) per unit: Rs.50
Total Units Held: 10,000 units (Rs.500,000 / Rs.50)
Withdrawal Amount: Rs.10,000
Units Sold: 200 units (Rs.10,000 / Rs.50)
Remaining Units: 9,800 units (10,000 – 200)
Remaining Investment Value: Rs.490,000 (9,800 units x Rs.50)
Month 2:
NAV per unit: Rs.52 (Let’s assume the market went up slightly)
Withdrawal Amount: Rs.10,000
Units Sold: Approximately 192 units (Rs.10,000 / Rs.52)
Remaining Units: Approximately 9,608 units (9,800 – 192)
Remaining Investment Value: Approximately Rs.499,616 (9,608 units x Rs.52)
Each month, Rs. 10,000 will be withdrawn until the investment is depleted or until the investor decides to stop. No matter how the market fluctuates, the number of units redeemed each month will vary; however, the investor receives a consistent cash flow.
Who Should Opt for SWP?
Choose SWP when:
- You’re retired and need a steady monthly income like a salary replacement.
- You have enough emergency funds and want to create a second income stream.
- You have a large corpus and want a systematic income flow that beats inflation.
Lumpsum Investment:
A lumpsum investment is when you put a large sum of money in a mutual fund all at once rather than spreading it over time as with SIPs. This strategy is appropriate for investors with a significant amount of money readily available, such as an inheritance, bonus, or the maturity of another investment.
Key Features of Lumpsum Investment
- Potential for Fast Gains (or Losses): If the market performs well shortly after your investment, you could see your money grow quite quickly. This is because your entire sum is working for you from the start. However, the flip side is also true: if the market dips soon after you invest, you could experience losses right away. It’s a bit like placing a big bet on a single outcome.
- One-time Investment: You invest a significant amount of money in one go and it does not require any periodic investments. This strategy is suitable if you have a significant amount of money available upfront.
- Risk of Market Timing: As you’re investing everything at once, the exact moment you invest can significantly impact your returns. If you happen to invest right before a market downturn, you’ll likely see initial losses. Conversely, if you invest just before a market upswing, you could see substantial gains.
How Lumpsum Investment Works
Example scenario: Let’s say Vikram invests his year-end bonus of Rs.2,00,000 in an equity mutual fund.
NAV is Rs.20
10,000 units allocated (Rs.2,00,000 ÷ Rs.20)
Now, let’s look at three possible market scenarios:
- If the market rises 20%:
New NAV: Rs.24 (Rs.20 + 20%)
Investment Value: Rs.2,40,000 (10,000 units × Rs.24)
Profit: Rs.40,000
- If market falls 20%:
New NAV: Rs.16 (Rs.20 – 20%)
Investment Value: Rs.1,60,000 (10,000 units × Rs.16)
Loss: Rs.40,000
- If market rises 30%:
New NAV: Rs.26 (Rs.20 + 30%)
Investment Value: Rs.2,60,000 (10,000 units × Rs.26)
Profit: Rs.60,000
This example shows why lumpsum investments can be both rewarding and risky – a 20% market movement, either way, means a Rs.40,000 gain or loss on your initial investment.
Who Should Opt for Lumpsum Investment?
Choose Lumpsum Investment when:
- You have a large amount of money available at once, like bonus, inheritance money, etc.
- You have a high-risk tolerance and are comfortable with market volatility since lumpsum investing exposes your entire investment to market conditions at a single point.
- You are experienced in stock markets and aware of how market volatility works.
Remember: Lumpsum investing requires not just money but also market knowledge and emotional discipline to handle market fluctuations. If you’re new to investing or prefer a more structured approach, starting with SIPs might be more suitable.
Wrapping Up
Understanding these four approaches is essential for making smart mutual fund choices. Remember, your choice between SIP, STP, SWP, or lumpsum should depend on three things:
- Your financial goals (what you’re saving for)
- Your current financial condition (how much and how you can invest)
- Your comfort level (how much risk you can handle)
Start small, learn along the way, and most importantly, stay consistent.
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