Mutual funds have become one of the most sought after investment vehicles in the last decade in India. Terms like SIP, STP and SWP have now become part of everyday household discussions. In this article, we discuss the various ways to invest and withdraw money from mutual funds.
Lump sum investment, redemption
Systematic investment plan (SIP)
Systematic transfer plan (STP)
A STP is used to systematically transfer money from one fund to another, often a liquid or other debt fund, to an equity-oriented fund. Since you are not investing new money every month (it can also be daily, weekly or quarterly), there is no bank debit on a periodic basis. The initial investment into the source fund is typically a lump sum investment followed by periodic transfer of money. So, every month the units of the source fund get redeemed and the investor is allotted new units of the target fund. An illustration for STP could be that you receive your yearly bonus of Rs 5 lakh, out of which you wish to invest Rs 3 lakh in an equity fund in a systematic manner. Here you can invest Rs 3 lakh in a liquid fund and start an STP of Rs 30,000 per month for 10 months. This helps in immediate parking of your intended investment into an avenue that is likely to grow. Remember, it is likely that after 10 months some money is likely to be left behind in the liquid fund, i.e., the appreciation part.
Systematic withdrawal plan SWP (SWP)
This feature offered by mutual funds is ideal for meeting your monthly cash requirements from an existing investment in a mutual fund, in case you do not have monthly income. This is a great tool for retirees to create their own pension streams from their mutual fund investments. You can set up an SWP in any existing mutual fund for any particular date of a month offering easy convenience without having to visit the mutual fund branch or having to remember to digitally redeem units every month. An illustration for SWP could be that of a retiree needing a monthly cash flow of Rs 50,000 from a mutual fund investment of Rs1 crore. Here, the investor can set up an SWP of Rs 50,000 per month on the first of every month for any period by specifying a start date and an end date. The money then is automatically credited to the investor’s bank account on the first of every month (or the next working day). Needless to mention the SWP will discontinue once the money in the mutual fund scheme is exhausted.
Systematic investing as a tool for managing risks: As you can see above, in each of the systematic tools, be it SIP, STP or SWP, a key objective to manage risk arising due to market fluctuations. Imagine you invested a large sum of money into an equity fund and immediately an event like Covid or Gulf War happens leading to a fall in markets. This can lead to serious erosion in value of your investments in the short term. If you are investing in the form of SIP or STP, some of your money is invested at lower market levels too, thereby smoothening your entry points. There is an element of averaging here. That’s why they say SIP / STP involve rupee cost averaging.
Similarly, imagine a situation where you redeem a large sum of money and the market goes up immediately. Here you have exited equities at lower market levels. On the other hand, if the withdrawal was through an SWP, every month a particular sum of money would get withdrawn, some of it at higher market levels too.
FAQs
If an investor fails to pay SIP instalment will there be a penalty?
In case a SIP instalment is missed, penalties are not levied. However, it is advised that no instalment is missed so that investments grow over a period of time.
What is the difference between SIP and STP?
While in a SIP, the money even if a small amount is invested periodically, in a STP, a lump sum is first invested in a liquid fund, and from there periodically transferred to whatever target fund is decided.