Though mutual funds are highly subject to market risks, despite it is one of the most lucrative investment avenues seen in the current market scenario. It can be seen that AMFI is highly promoting mutual fund investment through television commercials. When we talk about investment in mutual funds, the first & foremost thought that pops into our minds is SIP (Systematic Investment Plan). Even though, SIP is one of the safest and economical means of investment in a mutual fund; it is a tool for small players in the market. But if one has surplus funds lying idle, lump-sum or investment at once can prove to be a high yielding decision.
Factors to be considered before making lump-sum mutual fund investment
Parameter for Fund Selection
One of the most benevolent parameter as a reference for one-shot allocation of idle resources is the P/E (price per earnings ratio). Since equity mutual funds are a collection of shares, evaluation of funds on the basis of P/E ratio can be very helpful. P/E ratio is computed by dividing the market price per share (MPS) of the stock by its earnings per share (EPS). Suppose, MPS of stock A is Rs. 200 and EPS is Rs. 10, the P/E ratio is (200/10) = 20 i.e. stock A is trading at 20 times earnings.
P/E ratio of a mutual fund is the weighted average P/E ratio of all the stocks contained in the fund. The weights of the stocks are determined by their market values; let’s say, a fund consists of stocks of MN Ltd. worth Rs. 6,00,000 and PQ Ltd. worth Rs. 4,00,000, the total value of the fund Rs. 10,00,000, a weight of stock MN Ltd. is 60% and stock PQ Ltd. is 40%. If P/E ratios of stock MN Ltd. is 15 and stock PQ Ltd. is 10, then, fund’s P/E ratio is (0.6*15 + 0.4*10) = 13.
From the investment point of view, a lower P/E ratio is preferable. This implies that the average price of the shares in the fund as compared to the earnings of such companies comprising the fund is low. Lump-sum investment is favorable when the markets are at a low so that one can gain when the market starts improving.
Time the Investment
It is crucial to wait for the best opportunity to invest lump-sum in mutual funds in order to earn maximum returns. The best time for lump-sum investment in equity mutual funds is when the NAV (net asset value) of the fund is at its year’s low and there are probable chances to gain when the market takes an upturn. Investing when the NAV’s are low, larger units of a fund can be procured; this shall provide a broader base to earn when the fund makes an up-move.
Timing the market means how better one understands the market performance, predict the upcoming situation of the market, and allocate the resource when the best moment arrives.
The purpose of the investment should be to achieve the financial objective. If the investment is for the short term, it is better to invest in a liquid fund that is exposed to low risk and return and provides a hassle-free redemption option. Investment in a balanced fund is recommended for medium-term investment and for one having a long-term investment horizon, equity mutual funds can prove to be fruitful. Likewise, if the purpose is to save tax, then one can invest in ELSS funds which have a lock-in period of 3 years.
Must Read: – Top 6 things to avoid while investing in ELSS
Also, Mutual Funds require frequent monitoring to review whether the schemes are performing and attaining the determined objectives. Diversification of investment is necessary to reduce the risk that can arise from investment in a single fund if such fund starts deteriorating. Hence, funds churning and diversification ensures that the overall portfolio performs well despite any poor performance by a particular fund.
Consider the Tax Effect
Normally people invest in mutual funds by considering the return or yield capacity of the scheme, paying the least attention to the tax impact on the redemption of such fund. This can result in the drainage of a substantial portion of the gain made towards income tax. In the case of short-term investment; profit from investment in debt funds are subject to tax at the applicable slab rate and profit from equity-oriented funds are taxable @ 15%.
Profit from long-term investment, if the investment period is more than 3 years, debt funds attract a tax rate of 20% with indexation. However, Long-term capital gains from investment in equity-oriented funds are exempted from tax up to a gain of 1 lac. A realized gain of Rs. 1 lac and above in a financial year will attract a tax of 10%.
Systematic Transfer Plan (STP)
STP is a mix of SIP and lump-sum investment or a hybrid SIP. STP allows the periodical transfer of amount or units from one scheme to another of the same fund house, thus, helps in allocating funds at regular intervals.
One can target investment in an equity fund while remaining invested in a debt fund, thus ensuring high returns from equity funds and protection from part investment in debt funds.
The lump-sum mutual fund investment requires a cautious assessment of the factors affecting the market in which the investment is sought to be made. Resorting to these factors, you may be able to make a better investment decision.
How many of you are familiar with STPs?
I’m sure not many of you. Now with so many investment options available, people are confused in what to invest, where to invest and how to invest. Some people do not know what are the investment options available, and how to make the best use of them.
You may have different goals and dreams in life, but to fund those goals is a big task. It is always suggested that if you don’t know your way through the market, you seek help from an advisor. They will be able to guide you in the right path and help you build a bridge between your funds and goals.
You must be aware of Systematic Investment Plan (SIP) which is one good option to invest in mutual funds. In SIP, a fixed amount is deducted from your savings account every month and directed towards the mutual fund you choose to invest in. Systematic Investment Plans are a disciplined way to start investing to create wealth for the longer period of term.SIPs bring about a good saving habit in one’s routine, which is necessary.
Read More :- Importance of Continuing SIPs Amid COVID-19
Another option is STP (Systematic Transfer Plans), this is good for those investors who do not want to take the risk of investing a lump sum amount in a particular fund at one go. Especially in the current scenario, where the market is volatile due to COVID-19 pandemic, it is suggested to not invest lump sum. So Systematic Transfer Plans comes to your rescue.
Under Systematic Transfer Plans, an investor can invest a lump sum amount in a fund and transfer regular amounts, which are predefined by the investor, to another fund, on a specified date. You can make these transfers on a monthly, quarterly or even weekly basis. This is a better option than directly investing the whole lumpsum amount in a risky fund.
There are 2 types of STPs:
- Fixed STP: Over here, the amount that is to be transferred from one scheme to another is fixed. For example, Mr. A invested Rs. 100000/- in a fund ABC, and he has opted for a STP to fund XYZ, he wants Rs 5000/- to be transferred to fund XYZ on a monthly basis. Here we can see that Rs. 5000/- is the fixed amount that is to be transferred.
- Capital appreciation STP: Under this, the amount that is to be transferred will depend on the profit earned. This means that the investors want only the profit amount to be transferred to the other fund. Let us take the same above example to get a better idea, If after investing Rs. 1 lakh in fund ABC, he gains Rs. 6000/- (after a few months or a year) on it, the same amount of 6000 will be transferred to fund XYZ.
Now lets see how STP is relevant to you.
If an investor, who has a lump sum amount to invest, doesn’t want direct exposure in the equity market, can invest his lumpsum amount in a debt fund and through STP, transfer the amount he wishes to in the equity fund.
He can make the transfers monthly, quarterly or even weekly, as he wishes. However, one must keep in mind that, whenever an amount is transferred from one fund to the other, the units of that fund, from which money is going out, becomes less and units of the fund where the money is transferred increases.
Lets say, if the funds are being transferred from debt to equity, then the units in the debt fund will reduce and the units in the equity fund will increase.
Read More :- Understanding SIP, SWP and STP
STPs from debt to equities are more effective, when markets are volatile, and an investor does not want to take a risk. STPs are a better option than one time investments, in cases when the market is down which we are experiencing right now because of global pandemic. However, if we look at it the other way round, then one time investments would be a better option, if the markets are moving upwards. Having said all this, it is very difficult to predict the market scenario for a retail investor. So it is better for them to invest through STPs and get better risk adjusted returns, over a period of time.
STPs help investors reduce their risk, if the regular transfers are maintained. Just like how the concept of Rupee Cost Averaging works for a SIP, it can be applicable to a STP also. People usually think that when the market is down, they should redeem their money, before they make a bigger loss. However, people investing through SIPs, can avail this benefit.
Let us continue with earlier example to understand above point:
Mr. A invested Rs. 100000/- in a fund ABC, and he has opted for a STP to fund XYZ, he wants Rs 5000/- to be transferred to fund XYZ on a monthly basis. Now let us say in the 1st month, the NAV of fund XYZ was Rs. 10/-. So the no. units added will be 500 (5000/10). After a few months, if the NAV drops to Rs. 8/-, 625 (5000/8) more units will be added to the XYZ fund compared to 500 earlier.
In this example, you can see how an investor can take the advantage of the market when it drops. This example is taken also with a few months gap. Now, imagine if an investor keeps his money for years, how much will he gain.
STP is a tool to reduce risk, like SIP. The transfers should be made in a disciplined manner to avail this benefit. Well now you’ve understood all you need to know about STPs, so you can start planning for your investments, and make use of the funds you have in a proper and ‘Systematic’ way even during the current volatile market owing to COVID-19.
We all come across the terms SIP, SWP and STP very frequently while dealing with mutual funds. SIP, SWP and STP are all systematic and strategic investment and withdrawal plans in Mutual Funds. Depending on the requirements of an individual, one can opt for either of the methods. In a nutshell, SIP, SWP and STP are systematic ways to do a transaction in mutual funds. SIP is to invest. SWP is to withdraw. STP is to transfer. Given all these options, what should you choose for?
Let us understand each of these in detail.
Systematic Investment Planning
SIP is a method of investing small sums of money on a regular basis in mutual funds to build a corpus over time. Investors buy units at regular intervals. Here, the money gets transferred from your bank account to Mutual fund investment every month or any other frequency that you opt for. The frequency of SIPs can vary – you can do a quarterly, monthly, weekly or daily SIP.
It can help an individual to do goal based investments. It ensures effective planning as you can start an SIP for each goal. The goal could be children’s education, buying a house, wedding etc. One can start investing with as little as INR 500. SIPs not only instill a good saving habit in the investors but the power of compounding also helps amass wealth. By spreading out the investments an investor can average out his purchase cost. In more technical terms, it is called rupee cost averaging.
SIP is more suitable for investors who earn a salary and is a bit difficult for them to invest a lump sum amount in Mutual Funds. But at the same time, investing a part of salary every month is convenient. It also prevents you from committing all your money at a market peak, and hence maximises returns.
SIPs have limited use in debt schemes as they are not as volatile or risky as equity schemes.
In Fact, investing in Equity linked Saving schemes can help you get deductions upto INR 150000 under 80C.
When should you opt for SIP?
If you are in the earning phase of your life, then this is the time to accumulate wealth. What better way to accumulate wealth than SIP. SIP is a useful strategy in the accumulation phase.
Systematic Withdrawal Plan
An SWP allows you to withdraw a specific sum of money from a fund at regular intervals. An investor first accumulates the money in a Mutual Fund scheme in some number of years. Then, the investor starts to redeem the money from the Mutual Fund scheme at regular intervals depending on the requirements. The frequency of SWP can be weekly, monthly, or quarterly. Basically, we can say it is the opposite of SIP. Here, the money gets transferred from your Mutual fund investment to your bank account.
But SWP attracts tax as every withdrawal is considered a redemption and capital gain is applicable. Considering one will be accumulating for a long period of time, so at the time of withdrawal, LTCG tax needs to be paid. SWPs provide the investor with a certain level of protection from market instability and helps avoid timing the market.
When should you opt for SWP?
It is generally suited for retirees who are typically looking for a fixed flow of income. So instead of lump sum and adhoc withdrawals, it is best that you give SWP instructions to the mutual fund that a fixed amount, say, 30,000 should be withdrawn from the mutual fund every month and gets credited to your bank account. Not only for retirement, one can use SWP to meet education expenses of children which are required at regular intervals.
Systematic Transfer Plan (STP)
STP is a method through which an investor agrees to give permission to the AMC to transfer money from one scheme to another in a systematic and periodic manner. Generally, an investor invests a lump sum in one scheme and transfers a fixed amount to another scheme within the same AMC.
In STP, funds are transferred, so each transfer is treated as a redemption and does attract a capital gains tax.
One of the major advantages of STP is that an investor can earn a little extra on the lump sum in a debt mutual fund while it is being deployed in equity, since debt funds provide better returns than a normal savings bank account. It also helps to rebalance the portfolio regularly.
Systematic Transfer plan is of three types namely –
- Fixed STP – Here, the investor decides the fixed sum of money to be transferred from one fund to another.
- Flexible STP – In this type,the investor has a choice to transfer a variable amount. The fixed amount will be the minimum amount and the variable amount depends upon the volatility in the market.
- Capital appreciation STP – Here, the investor takes the gain part out of one fund and invests in the other.
When should you opt for STP?
One opts for an STP when there is a lump sum amount to invest. It is suitable for individuals who have excess idle money lying in their account and are reluctant to invest the entire amounts into equity funds. As investing a lump sum in the equity market is not recommended looking at its volatility. In this case, the money is invested in a debt fund preferably a liquid debt fund and instructions are given to the mutual fund that a fixed amount should be transferred from debt mutual fund to equity mutual fund. That’s one way of using STP.
A person can also do an STP from equity mutual fund to Debt mutual fund. This will be used when a person is investing in an equity MF for a long term goal, say for Children education . But when a person is near to the goal, it is suggested that you start moving your money from equity funds to debt funds to reduce risk because of short term market volatility. This can be done by STP.
I hope that the difference is now clear among each of these SIP, SWP and STP options. With every method having its own set of features and advantages, an investor has to be careful while choosing the best option for him by considering the modalities and the suitability of the scheme and his goals.
Disclaimer: The views shared in blogs are based on personal opinion and does not endorse the company’s views. Investment is a subject matter of solicitation and one should consult a Financial Adviser before making any investment using the app. Making an investment using the app is the sole decision of the investor and the company or any of its communication cannot be held responsible for it.
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