Systematic investment plans (SIPs) are the intelligent and affordable way of investing in mutual funds. In the pages of MONEY TODAY we have explained and argued for SIPs more than once (see pg 20 of issue dated 12 July) and reiterate some of that in this issue (see pg 73).
The magic of SIPs lies in their convenience. The investment in instalments helps the smallest of investors acquire the most potent tool of wealth creation—power of compounding.
This magic is not restricted to SIPs alone. It works—in different ways and for different needs—with systematic transfer plans (STPs) and systematic withdrawal plans (SWPs) as well. Here’s how these two lesser-known cousins of SIPs work, and how you can use them to reach your financial goals.
SYSTEMATIC WITHDRAWAL PLANS
This is the opposite of an SIP. A fixed amount is redeemed on a predetermined day of the month and paid to the investor.
Who are they for: SWPs are especially useful for retirees who need a steady stream of income. A month -ly dividend option can also do the same but there is a steep 14-28% dividend distribution tax (DDT) on dividend paid on debt and debt-oriented mutual funds.
How do SWPs help: DDT is compulsorily deducted by the mutual fund regardless of the person’s tax status.To avoid DDT, go for the cumulative option and start an SWP.
Customised cash flow: SWPs allow investors to customise the cash flow to their needs. Imagine a pensioner who needs Rs 10,000 a month for expenses but gets a monthly dividend of only Rs 7,000. He would be better off with an SWP of Rs 10,000. Of course, that would deplete the corpus by around Rs 3,000 a month.
Lower tax: Profits from the sale of units being redeemed by every withdrawal are taxable. In the first year of investment, the profits are taxed at normal rates. But after a year, the profit is treated as longterm capital gains and taxed at a lower rate (see page 20).
SYSTEMATIC TRANSFER PLANS
In STPs, a fixed sum is switched from one fund to another every month.
Who are they for: Investors with a large investible corpus who want to have a taste of equity with minimum risk.
How do STPs help: An STP is an SWP-SIP combo. The investor can put a lump sum in a debt fund with an STP that transfers a small amount into an equity fund every month. Suppose you invest Rs 5 lakh lump sum in a bond fund with an STP of Rs 10,000 into the equity fund. You would be transferring about 2% of the invested amount into the equity fund every month.
Customised risk: The amount to be transferred can be customised to suit the risk appetite of the investor. If you can take risks, raise the STP amount to Rs 15,000-20,000 a month. The principal scheme itself can be one with a tinge of equity—such as a monthly income plan.
Principal protection: If market volatility makes your stomach churn, go for a capital appreciation STP. The mutual fund will transfer only what the principal fund has earned during the month. That way, your invested amount remains untouched.
Lower tax: If the principal scheme is a debt fund, the profits are treated as capital gains and taxed at a lower rate (see SWPs ).
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