You must have heard about the 7 wonders of the world. Aren’t they so amazing? But do you know about the 8th wonder of the world?
Yes, you heard that right. No, it is not another magnificent architecture or a monument. It is the concept of Compounding.
You may be thinking how is that even on the list? If that is what you thought, I, Amisha Gupta, will clarify this newfound curiosity here.
Compounding or compound interest is the additional interest earned upon interest on principal amount.
Suppose you invested ₹10,000, at 12%, for 2 years. By the end of 2 years with the given amount, your investment would have amounted to ₹ 12,697.35 with estimated returns of about ₹2,697.35 due to compounding.
Nowadays, many investment options serve different types of financial goals. One such popular option is Mutual Funds. A mutual fund is a collective basket of stocks, bonds, and different types of asset classes offered as one financial product with each investor constituting percentage capital in the pool of funds.
Mutual funds equip you with the ability to get your hands on diversified and professionally managed portfolios with a small annual fee charged by fund-managing companies known as expense ratio. You can invest your hard-earned money in some of the best-performing mutual funds. The categorization of Mutual funds is based on the percentage of equity/debt purchased, whether the fund is actively or passively managed, solutions oriented funds like retirement and child welfare. Some funds are theme based as well. For example: An Infrastructural Thematic Fund will include stocks related to all the companies and industries having their day to day business around infrastructure such as companies in steel, cement industries, companies making heavy machines etc.
Now, you must be wondering how to buy/invest in these mutual funds and brag about those gains like market techies around you. So, let me finally break it to you some of the most smart ways to invest in Mutual funds apart from investing in lump sum or all at once:
Systematic Investment Plans
SIP stands for Systematic Investment Plan which, as the name suggests, is a structured way of investing.
It is an attractive option for those who wish to invest periodically and draw benefits in the long run. When you start your SIP, you pay a specific amount of money, every month, to be invested in chosen mutual funds.
Key features of an SIP
Let’s look at some of the primary characteristics of a SIP that are defining in nature.
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Consistent investments
If you wish to begin your investment journey this year, SIPs are one of the best ways to do so. Given the simple structure, anyone can start investing with amount as less as Rs.500.
Mutual funds usually carry a financial goal with them. This can be a retirement fund, education, or even wealth creation. Investing in mutual funds through SIPs helps you become a better investor by teaching you the importance of disciplined investing.
Simply put, a SIP requires you to invest a fixed amount (for example rs 1000) for a specific period in a preferred fund, which drives your returns in the long run. You also get the benefits from concepts like rupee cost averaging and compounding.
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Ability to customize
From choosing the type of Mutual fund you invest to how much you invest, a SIP gives you the liberty to ‘personalize’ your investment. Depending upon your goals and the risk appetite you have, you can decide on the SIP amount, the investment time horizon, and the SIP start and end date.
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Rupee cost averaging
Rupee cost averaging aims to significantly reduce the impact of market fluctuations over a long period. It consistently invests a fixed amount in mutual funds, irrespective of their ongoing market prices. When the prices are low and stocks are undervalued, you buy more, and when they are high and might be overvalued, you buy fewer just like a rational investor. This helps you to avoid the stress due to any short-term fluctuations in the market, while potentially earning more in the long run. SIP through this concept keeps you invested for longer periods.
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Compounding advantage
To understand compounding, we will first elaborate on simple interest through a common example.
Lets say, You decided this diwali, to put your savings in a piggy bank, say Rs 5000 and every diwali you will deposit 10% of this amount. Now you, irrespective of whatever amount in the piggy bank, kept on depositing Rs. 500. After 10 years, you would have collected a simple interest of 5000 on your principal of 5000.
Dissatisfied, with the interest you accrued, you decided to opt another approach.
You decided every year, you would collect whatever amount is there in your piggy bank and redeposit it back with an additional 10 percent. At the end of 1st year, however, the case would be the same as of earlier. Onwards, 2nd year, you would notice, you are required to deposit 550 rs. When the pattern is followed for a time period of ten years, you would have collected an amount of 13000 (5000 + 8000) approx, which is 3000 more than previous case.
This phenomenon is an integral part of the SIP framework. Over time, with each additional investment and the compounding nature due to growth in investments, you can greatly improve your returns, as both the initial investment and the returns begin to generate returns. This is similar to the snowball effect that is accumulated with time, which accelerates the process of your wealth creation over time.
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No need to time the market risks
Unlike other investments, you don’t need to constantly time the market to look for ‘risks’ and ‘opportunities’. A SIP lets you take a back seat and watch your investments work. This is one of the attractive features of SIP as an investment option. With regular investment irrespective of market highs and lows, you can stay consistent with your investments.
Who is it ideal for?
Systematic Investment Plans (SIPs) benefit a wide range of investors, with three common beneficiaries being
- Long-Term Investors:
For long-term investors, SIPs provide a systematic method of wealth growth that takes advantage of compounding over time - Salaried-Individuals:
Salaried people benefit from the ease and cost of SIPs because they allow them to invest small amounts regularly without exceeding their monthly budget. - First-time mutual fund participants:
SIPs are also appealing to new mutual fund investors because of their simplicity and convenience of usage.
By automating investments and eliminating the need for active market participation, SIPs give a low-risk entry point into the world of investing, assisting newbies in navigating the complexities of financial markets while steadily increasing their portfolios for the future.
Systematic Transfer Plan (STP)
There are times when a particular fund seems to be deriving bigger and better returns than what you are currently invested in. Therefore to avoid missing out on potential gains, you have the liberty to shift your investments from one certain scheme to another scheme of the same AMC. This process is called a Systematic Transfer Plan. Let’s understand what it is and how it works.
A Systematic Transfer Plan (STP) is an investment strategy wherein you transfer money from one scheme to another at fixed intervals. It is commonly confused with SIP in which you invest a small amount every month, whereas an STP takes a lump sum as the principal investment amount from which a small amount is reinvested in Mutual funds of the same AMC as per investor choices. This aids in making the necessary portfolio adjustments.
Key Features of Systematic Transfer Plan
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Ease of transfer and better returns
It allows you to move money between funds periodically giving the advantage of drawing better returns, meaning that you can move your money from your current plan to a potentially better performing one of the same asset management company (not two different AMCs), and extract the benefits of higher returns. This is seen as a helpful tool during market fluctuations and underperformance.
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Ability to control the investment:
Along with choosing the target scheme you want to invest in, you can also determine a specific amount that will be invested in the new scheme. It also allows for setting of investment frequency as daily, weekly, monthly, quarterly, and annually. This feature makes it an attractive option for beginners and people with less risk appetite.
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Set it up and relax:
Once you have begun the process of transferring money from the source scheme (already invested scheme) to the target scheme (where you want to invest), the transfers happen automatically as per set protocol. You do not need to keep an eye on the process or manage anything.
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Tax considerations:
When you switch between two different schemes of the same AMC, you have to pay taxes on the capital gains (both long term and short term).
Who is it Ideal for?
If you have a lump sum amount which is a large sum of money that you want to invest in different mutual funds across time and around market scenarios, then it can be considered.
Instead of taking the risk of putting the entire sum into the market at once, an STP will allow you to work this capital slowly and steadily. This mitigates the risk significantly and provides you with a smoother functioning investment portfolio.
The next category of investors, fit for STP, are those who are concerned by the rapid alterations of the market’s mood. By considering a steady rate of transfer of funds you can safeguard your money from being affected by the market volatility.
After years of religiously investing, your investments accumulate a large sum of money. Now you wish to withdraw this cash and use it to support your goals and needs. But how? Can you withdraw the entire corpus? Or do you get half of it? Lets first dig out what is a Systematic Withdrawal Plan.
Systematic Withdrawal Plan (SWP)
The Systematic Withdrawal Plan (SWP) allows you to withdraw money from your mutual fund schemes regularly like a salary every month.
It works like this: You select a specific amount to withdraw regularly, at regular durations such as monthly or quarterly. You can also choose how much you wish to withdraw while leaving the rest of your investment unaffected.
This offers you a consistent and stable inflow of money.SWP is ideal for retired individuals who require a monthly income. It is also fruitful for individuals who want to use their investments to get a monthly withdrawal.
Key features of SWP
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Steady Income:
SWP allows investors to take a predetermined fixed amount at regular intervals from their mutual fund investments. This feature offers a continuous income stream throughout time, promoting financial stability and predictability.
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Customizable:
Investors can adjust the frequency of withdrawals based on their financial needs. SWP can be modified to meet their specific cash flow needs, whether daily, monthly, quarterly or yearly.
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Active Participation:
SWP allows investors to withdraw only a portion of their investment while keeping the rest invested. This flexibility allows investors to meet their liquidity demands without having to dissolve their entire investment. They still get the opportunity to keep themselves invested in the market and enjoy gains.
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Tax Efficient:
Withdrawals made through SWP may be tax-efficient, especially if the investment has been held for the long term. Depending on the capital gains tax and the holding period, investors may benefit from lower tax rates on their withdrawals.
SWP provides investors with a reliable source of regular income. SWP allows investors to change their cash flow management according to their specific financial needs and goals. Whether it’s supporting retirement expenses, education costs, or any other financial obligation, SWP offers a custom-made approach to managing cash flows efficiently.
SIP vs STP vs SWP: Comparison and Contrast
What are the Similarities?
All three involve a structured and defined way of investing. These methods teach you how to commit to a disciplined transaction schedule, be it investing, switching, or withdrawing money.
They not only allow you to comfortably invest, transfer and withdraw your funds but also alter the structure in the way that best suits you.
What are the Major Differences?
SIP is majorly used for investing money into mutual funds consistently. It aids in building wealth with time by taking small steps regularly.
STP involves transferring investment from one mutual fund scheme to another as per set terms and conditions. It’s most commonly used to restore portfolios, manage risk, or shift funds between different funds to align with market scenarios
SWP as the name suggests, is structured for taking out money from mutual fund investments at regular intervals (like a monthly salary) to provide a steady income stream. It is highly recommended for retired people or those who want a stable cash flow from their investments.
Tax implications and financial goals
Withdrawals on investment and returns generated thereof through SIP, are charged with taxes, depending on the duration of time they are held. Long Term Capital Gains (LTCG) are taxed at 10 % after exemptions of up to 1 lakh on such gains, whereas, Short-Term Capital Gains (STCG) which are withdrawn within 1 year are taxed at flat 15%, followed by surcharge and cess.
Systematic Withdrawal Plan (SWP) withdrawals, can trigger tax deductions, depending on parameters such as investment duration and type of income produced.
STP transactions may have tax implications similar to that of SIPs or SWPs, based on the nature of the base investments. STP’s aims include creating a portfolio that has assets of a wide range, risk mitigation, and gaining investment objectives with the help of organized transfers
The Key Takeaway
By now it might be evident that you don’t need to time the markets or conduct in-depth analysis. Picking the right investment plan among SIP, STP, and SWP is critical for reaching your financial objectives.
We, at BFC Capital, provide carefully curated financial plans, regular portfolio reviews, and expert guidance to help you achieve your financial goals with ease.
With the right assistance, you too can make informed decisions and optimize your investment strategy to effectively attain your financial goals.
