The mutual fund industry has, through the years, proved to be highly innovative in churning out a plethora of products. Consequently, the canvas of offerings has become crowded and the average investor is often confused about how best he could achieve his financial goals. Let’s look at four terms that are frequently used in discussions about mutual fund investments:
- Systematic Investment Plan (SIP)
- Systematic Transfer Plan (STP)
- Systematic Withdrawal Plan (SWP)
- Trigger Facility, and their convergences
To begin with, here’s a snapshot of what these four terms mean.
Systematic Investment Plan (SIP)
The objective of a SIP is to accumulate a amount over a period of time by making small but regular investments in units of a mutual fund.
Systematic Transfer Plan (STP)
A Systematic Transfer Plan (STP) is a mechanism through which an investor transfers units from one scheme to another scheme of the same mutual fund house. We will see a little later why and when an investor would want to make such a transfer.
Systematic Withdrawal Plan (SWP)
A Systematic Withdrawal Plan (SWP) is for conversion of mutual fund units into bank balance in a phased manner for a regular flow of income.
The investor defines a specific event, time or value, on the happening of which, the accumulated units are redeemed for cash or switched to another plan within the scheme or to another scheme but with the same fund house.
The Magic of Mutual Fund Investments
Let’s take the case of Ramesh Manchanda. On January 1, 2008, Ramesh’s bank account was credited with an amount of Rs.12,00,000/- (12 Lakhs); his share from the sale of an ancestral property. Ramesh required the money for his personal use only from January 1, 2016. He could, therefore, have invested the amount in a Fixed Deposit with interest at 9% per annum for a period of 96 months (8 years) upto December 2015. The maturity value of his Fixed Deposit would have been Rs.22,33,155/- (22.3 Lakhs).
But, starting with the very same amount of Rs.12,00,000/-. Ramesh built an amount of 36,56,391 (36.5 Lakhs). Isn’t that amazing? That’s the magic of investing in mutual funds
To start with, Ramesh decided that he should invest the money through a SIP with an equity fund. But, where would be hold the funds until the time that they were deployed in the equity fund? His options were a fixed deposit scheme with a bank or a debt scheme of a mutual fund. Ramesh chose the debt fund. Why? Here’s the answer.
|Year||Fixed Deposit (interest at 9% per annum)||Debt Fund (return of 7.15%)|
|Sum on 1 Jan||Sum on 31 Dec||Sum on 1 Jan||Sum on 31 Dec|
- Interest on deposits is subject to deduction of tax at source from the first year whereas tax on earning in a debt fund is payable only at redemption. That accounts for the higher year ending balance in debt fund in the first year itself even though the debt fund return is lower than the fixed deposit interest rate;
- The benefit of indexation is available at the time of redemption of the investment in a debt fund. Owing to indexation benefit, Ramesh paid no tax on earnings in the debt fund whereas interest on fixed deposit would have been subject to tax at 30%
Ramesh went ahead and invested the amount of Rs.12.00 lakh in a Debt Fund on January 1, 2008.
STP from Debt Fund to Equity Fund
The Asset Management Company (AMC) was given a mandate to transfer Rs.20,000/- on the 7th of every month from the Debt Fund to the Equity Fund for a period of 60 months commencing from 7th January 2008 upto 7th December 2012. Let’s have a look at the results of Ramesh’s decision.
|Amount (Rs.) transferred||Balance units in account||Market Value (Rs.) of balance units on December 31, 2012||Return (%)|
- units worth Rs.12.00 lakh have been purchased in the Equity Fund and Ramesh still has a balance of accumulated units in the Debt Fund having a market value of Rs.2,57,564 (Rs. 2.57 Lakhs) which his profit.
|Amount (Rs.) invested||Units accumulated in account||Market Value (Rs.) of accumulated units on December 31, 2012||Returns (%)|
- Ramesh’s investment of Rs.12.00 lakh through SIP over a period of 5 years is worth Rs.23,74,210 (Rs. 23.74 Lakhs) on December 31, 2012.
STP from Equity Fund to Balanced Fund
Ramesh knew that he would require the funds to be available for his use from January 1, 2016. Therefore, he had issued a date linked trigger to the AMC to transfer the balance in his Equity Fund to a Balanced Fund. The date trigger was set for January 1, 2013. The instruction was to complete the transfer in monthly instalments each of Rs.1.00 lakh. Beside the value of Rs.23.74 lakh in his equity fund, Ramesh also decided to plough in his profit of Rs.2.58 lakh from his debt fund investment. The final amount of Rs. 27,52,642 (Rs. 27.5 Lakhs) transferred and invested in the Balanced Fund also included a sum of Rs.1,20,867 (Rs. 1.20 Lakhs) that represents further earnings in the Equity Fund during the 2 years period of transfer.
Now for the results.
After the transfer of units, there was no balance of units in the Equity Fund (all units having been transferred to the Balanced Fund). The position in the Balanced Fund was:
|Amount (Rs.) Invested||Number of units accumulated||Market Value (Rs.) of units on December 31, 2015||Return (%)|
- Ramesh began with a corpus of Rs.12.00 lakh on January 1, 2008 but, at the end of 8 years on December 31,2015, without doing anything spectacular, that amount had swelled to Rs.36.56 lakh;
- The Compound Annual Growth Rate works out to 14.94%
Rationale for STP from Equity Fund to Balanced Fund
Investors should keep track of their financial goals, time frame and, at a reasonable time before the funds are required, take steps to protect their investments. If the corpus built is really substantial, this measure could be introduced even 3 years ahead of the goal date (Ramesh started more than 3 years ahead). The Balanced Fund return of 16.04% was much lower than the return of 27.83% from the Equity Fund. But, at such times, the focus must be more on investment protection and less on return. No investor should take the risk of his accumulated wealth going up in smoke because of untimely market volatility.
SWP from Balanced Fund to Bank Account
On January 1, 2016, the trigger Ramesh had lodged with the AMC came into force and the fund house started redemption of units from the Balanced Fund for credit to the bank account designated by Ramesh.
- The STP route can be used for transferring funds from the source fund to more than one other fund provided all the funds are managed by the same fund house;
- Decide the target funds first and make sure that the fund house permits switches from the proposed source fund to the target funds;
- Keep the number of transactions from debt fund to equity fund as low as possible so that the funds start earning higher returns sooner;
- If the fund house does not have an appropriate target scheme for a STP, the investor could choose to implement a SWP. The redeemed units could then be transferred through SIP to the mutual fund of his choice (instead of travelling directly from scheme to scheme, the investment would be routed through a bank account;
- Use the STP route only if a sizeable amount is to be temporarily invested in a debt fund for subsequent transfer to an equity fund. Otherwise, the incidence of tax and exit load may render it a less than attractive proposition
Good for Investors to Know
- With a STP, the investor exits from one plan/scheme and invests in another. Capital gains tax would be attracted for units redeemed from a debt fund;
- Debt funds are eligible for indexation benefits. Thus, tax incidence, if any, may not be significant;
- Equity mutual funds are tax free after 1 year of investment.
- Exit load would be applicable if the units purchased have not been held for more than 1 year.
A Smooth Route
The SIP in equity mutual fund followed by STP to a balanced fund and, thereafter, SWP for a regular flow of monthly income route along with judicious use of the trigger facility should be integrated by investors for their benefit. The path would be:
STP from debt fund (if beginning with a lump sum amount) SIP in equity fund STP from equity fund SIP in balanced fund SWP to bank account
The route used by Ramesh was:
- STP from ICICI Prudential Corporate Bond Fund – Growth Option (Debt Fund)
- SIP in ICICI Prudential FMCG Fund – Growth Option (Equity Fund)
- STP from ICICI Prudential FMCG Fund – Growth Option (Equity Fund)
- SIP in ICICI Prudential Balanced Advantage Fund – Growth Option (Balanced Fund)
- SWP to Savings Bank Account
The SIP, STP and SWP structures complement one another and that should be exploited by investors to achieve their goals. For a heady cocktail of rewarding returns, risk mitigation, automated financial planning and management of financial goals, put the combination of SIP + STP + SWP + Triggers to work for you.
(This article provides general advice and recommendations and does not constitute personal advice. While the calculations are accurate for the period to which they refer, the opinions and examples in this article are for informational and educational purposes only. I have never invested in any of the funds named in this article. The statements in this article should not be construed as advice to invest in the funds named. Mutual fund investments are subject to market risks. Investors are advised to perform personal due diligence before investment. Ramesh Manchanda is a fictional person. Any resemblance to any person, living or dead, is purely coincidental)
- freefincal. Personal Finance Calculators. 29 Jul 2013. Web. 24 Feb 2016
- ICICI Prudential Mutual fund. SWP and STP Calculator. Web. 24 Feb 2016
- Reddy S. Mutual Funds Taxation Rules – Capital Gains Tax Rates on MFs – FY 2015/16. relakhs.com. Web. 24 Feb 2016