Explained: What does SIP, SWP, and STP in mutual funds mean? When to use them?

If you want to invest in the market but are cautious about volatility and risk, mutual funds offer a relatively safer option. Instead of making a lump sum investment in a scheme, a more strategic approach is to invest systematically. This involves spreading your investments over time by contributing fixed amounts at regular intervals. The same method can also be applied when shifting investments between schemes or withdrawing funds. Here’s how the systematic approach in mutual funds works and why it can be beneficial.

Systematic Investment Plan (SIP)

A Systematic Investment Plan (SIP) is a method of investing a fixed amount in mutual funds at regular intervals—weekly, monthly, or quarterly. So, instead of a lump sum, you invest a pre-decided amount at regular intervals for a defined period. It allows investors to accumulate wealth over time through disciplined investing and the power of compounding.

Benefits of SIP

Rupee cost averaging – This method helps to tackle market volatility by averaging the cost of buying mutual fund units. If the market falls, one can buy more units at lower NAV or vice versa. Over the long term, the cost of purchasing is leveled out, which helps in riding the market volatility better.

Compounding – A small amount of money invested over a period of time gain from compounding, boosting the investment.

Flexibility and disciplined investment – The SIP method is flexible as it allows you to invest the amount you want to invest and the period for which you want to invest. It also results in disciplined investing.

When to Use SIP:

One can use SIP when they want to invest regularly without worrying about market timing and when they have a long-term financial goal, such as retirement or a child’s education. One can use a systematic investment plan when they want to benefit from rupee cost averaging, which reduces the impact of market volatility.

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Systematic Withdrawal Plan (SWP)

A Systematic Withdrawal Plan (SWP) enables investors to withdraw a fixed amount from their mutual fund investments at regular intervals. It is ideal for individuals looking for a steady cash flow while keeping their remaining investments intact.

Benefits of SWP

Regular income – SWP helps to provide a regular cash flow for specific goals or needs and can even act as a source of monthly income during the retirement period.

Capital appreciation – If the withdrawal rate is lower than the growth of the mutual fund corpus, the capital can grow even as the investor derives a regular income.

When to Use SWP:

One can use SWP, when they need a regular income, such as during retirement or when they want to withdraw money in a tax-efficient manner instead of redeeming a lump sum. One can even use this method when they want to reduce market risk by withdrawing only a portion of their investments while keeping the rest invested.

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Systematic Transfer Plan (STP)

A Systematic Transfer Plan (STP) allows investors to transfer a fixed amount from one mutual fund scheme to another at regular intervals. Typically, investors use STP to shift funds from a debt fund to an equity fund (or vice versa) to balance risk and optimize returns.

Benefits

Low risk and high return – One can manage risk in market swings by shifting to a low-risk scheme or move to a high performing scheme in an upswing.

Stable portfolio – A STP helps an investor to move out of an underperforming scheme while allowing them to maintain the balance between debt and equity to maintain the desired asset allocation.

When to Use STP:

One can use STP, when they have a lump sum amount but want to stagger their investment into equities to reduce market timing risk or when they want to rebalance their portfolio by moving funds from equity to debt or vice versa. One can even use it when they wish to systematically invest the proceeds from a maturing fixed deposit or a large inflow of money.

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Key differences between SIP, SWP, and STP