systematic withdrawal plans (STPs) are for optimal and efficient investing
EARLIER in this series, we discussed the investment and redemption strategies of systematic investment plans (SIPs) and systematic withdrawal plans (SWPs). SIPs let you invest a specified sum of money at specified intervals—generally weekly, fortnightly, monthly or quarterly—irrespective of market conditions. SWPs let you withdraw money systematically from funds, as opposed to lump sum withdrawals. This week, we look at a plan that combines the best of systematic withdrawal and investing—the systematic transfer plan (STP).
An STP withdraws a pre-specified sum of your money from one scheme, and invests it another within the same fund house, at regular intervals. It thus lets you re-allocate your from a liquid fund (a money market debt fund with low risk, but much higher returns than a bank savings account) to one or more equity schemes of the same fund house. As there is no exit load on a liquid fund, nothing is deducted for the transfer from the liquid fund. However, investment in the equity fund may be subject to entry and exit load.
So an STP squeezes the maximum juice out of your regular investments, so that the money sits in a liquid fund account while waiting to be invested, instead of in a bank account that yields a lower interim return.
STPs are a systematic investing tool. The key to astute financial planning is to start early and invest on a regular basis. Such disciplined investing lets you fulfill financial obligations and long-term goals. STPs are best for retail investors who have surplus liquidity to invest in equity, but who lack the expertise and knowledge of market dynamics. STPs enhance returns on the surplus liquidity by keeping it in a liquid fund, instead of letting it idle in a savings account. Your money earns only around 0.50% a year in a savings account, but a liquid fund gives you 7% or more a year. Thus, an STP optimizes your returns while performing a similar function to an SIP.
Let’s take an illustration to understand how an STP can make a difference. Suppose an investor wants to invest Rs 75,000 in equity mutual funds. Rather than put all her money in an equity fund at one go, she can park the entire amount in a liquid fund relatively more safely. She can then opt for a monthly STP that will transfer Rs 5,000 each month to the equity fund, for the next 15 months. This helps ensure her money is invested in a systematic manner, over a period of time, no matter what the condition of the market. As long as there is a balance in the liquid fund, it will continue to earn returns.
If you invest through a SIP, you probably have liquid money idling in your bank account. Consider transferring it to a liquid fund, and earning twice the returns that your savings account is giving you. This higher return rate will apply to the balance in your liquid account, until all of the money is transferred to the equity fund account.
It is well known that timing the market is a tricky task, even for seasoned investing experts. Often, what drives stock prices is sentiments, not fundamentals. Timing the markets requires a high degree of expertise and skill—generally not the forte of most retail investors. A poor understanding of market dynamics can lead to heavy losses to investors. Thus, the volatility of equity markets often puts investors off. But STPs ensure disciplined investing, regardless of whether the market is going up or down. It thus mitigates the risk arising from volatility. Systematic regular investment irrespective of the state of the markets leads brings down the average purchase cost over time. This phenomenon is known as “rupee cost averaging”. When you invest a fixed amount at regular intervals, you end up buying more units when their NAVs are down, and fewer when they are costlier. A lower purchase price, of course, translates into higher returns. And an STP facilitates cost averaging while also allowing your money to earn better returns while it’s in waiting mode.
Now, you may ask, “Why opt for an STP instead of a SIP?” A SIP is an ideal way to invest, if there are regular cash flows and you can match these with the intended investments into mutual funds. In a SIP, typically, a salaried investor deposits a monthly pay cheque into his savings account, and out of this a certain pre-determined amount is transferred at a regular interval the savings account into a specified equity fund. But if there are already some accumulated savings in his bank account—money in excess of his requirements—then he can transfer it to a liquid fund account out, of which his equity investments will get deducted at specified intervals. Thus the investor takes advantage of higher returns accruing in a liquid fund.
One fear many investors expressed is that mutual funds might constrain their liquidity. But liquid funds are designed—as the name suggests—to offer very high liquidity. Your money is generally available at a day’s notice—not too different from the degree of liquidity in a bank’s savings account. When you need the money from your liquid fund account, you can have it credited to your bank account the next day. So why not keep it in a liquid fund, then, and opt for an STP, if you’re not really compromising on liquidity? The only drawback of an STP is that you can’t invest your money from one fund house’s liquid fund to another fund house’s equity fund. You would be constrained, if investing through an STP, to choose a liquid fund from the same fund house. But it’s not a significant limitation when you consider that there’s little difference in returns delivered by various liquid funds. So STPs are quite a viable option.
Systematic long-term investing through an STP enables you to reap the benefits of compounding. Essentially, compounding enables you to earn interest on interest. As time passes, compounding makes your investment grow increasingly rapidly. With inflation breaching the 7% mark, it has become imperative to regularly invest your money, to protect the erosion of your savings. By investing through an STP, you can get the same benefits as from a SIP, but with higher holding period returns. So you can get optimal returns on your investments.
