Investing in mutual funds is not a one-time activity. An investor needs to keep monitoring his portfolio of funds and keep making changes as and when required to ensure that the portfolio remains in line with his objective.
There are certain facilities which mutual fund companies provide which assist in making investments and predetermined transfers between schemes easy. Let’s take a look at two of them.
Systematic Investment Plan
A Systematic Investment Plan (SIP) is a facility that helps investors invest regularly and systematically in mutual funds. It is based on commitment which enables an investor to be disciplined toward investing in mutual funds.
To opt for this facility, an investor needs to first choose fund(s) which suit his investment objective. Then, he has to decide the amount(s) that will be directed towards the chosen fund(s) as well as the date on which the said investment will be made. He also needs to choose the periodicity of investment. Though he can choose to invest in longer or shorter periods, typically SIPs are set up to invest monthly. This facility is immensely beneficial to investors.
Firstly, it is very convenient. Once an investor sets it up, he does not need to get worried about forgetting to invest. The ease of setting an SIP up and managing it makes mutual fund investing a breeze. At the click of a button, one can start an SIP; all one needs to do it choose the suitable fund(s).
Secondly, it makes investment a habit. Once an SIP is set up, it forces the investor to ensure that ample funds are available in his bank account so that this investment can continue. Thus, an investor is compelled to save and committed to invest. Given that regular investing is a difficult habit, but can be rewarding in the long term, an SIP helps an investor inculcate this habit.
With an SIP, an investor can make use of rupee cost averaging. According to this phenomenon, the cost of holding an instrument averages out over a long period with regular investment. Since one typically invests monthly while using the SIP facility, the investment is regular. If done over a period of time in a sustained manner, it would result in averaging out the cost. This happens because when the NAV of the fund(s) is high, one would be allotted less number of units than when the NAV is low. Given that the upward and downward movement averages out in the long term, it would also result into the averaging out of the holding cost as well.
Investing over a long period also results into another benefit: the power of compounding. Giving one’s investment a long period to grow allows the power of compounding to work its magic. The longer one stays invested, the more the possibility of a large corpus – even at a relatively low rate of return.
SIPs also take away the need to time the market. With consistent investment in good funds, one does not need to worry about whether markets are low enough to buy, or even if markets are declining. Over the long term, volatility in markets tends to normalize, which can reduce its impact on portfolio returns. In this manner, SIPs can help you navigate volatility in markets.
After this brief outline of SIPs, let’s take a look at STPs.
Systematic Transfer Plan
An STP is a facility which allows an investor to permit a fund house to either transfer a pre-decided amount or switch a certain number of units from one scheme to another over set periods. Switching essentially means redeeming certain number of units from one scheme and investing into another like a fresh investment. The only condition is that the schemes in which STP is being carried out need to be offered by the same fund house.
The purpose and benefits of this facility may not be immediately apparent so let’s look at it in a bit more detail. Suppose an investor is nearing the end of a part of his investment cycle or is about to complete one of his investment objectives. With prior knowledge of the same, he does not need to wait for the period to end or for the goal to be achieved. Doing this may entail risk in the form of market underperforming as he completed his investment period. To take care of this volatility, he can decide to set up an STP and start moving his money from the riskier scheme to a comparatively low risk scheme. In this scenario, he may decide to transfer his holdings from an equity fund to a debt or liquid fund.
The other aspect holds true as well. For instance, the equity market may have bottomed out and may be on the cusp of recovery. However, one may not be sure about jumping into equity investing straight away without further proof of an uptrend. In such a case, an investor may use an STP to slowly start deploying money into an equity fund while remaining invested in a liquid or debt fund. In this manner, this facility can help an investor maintain a balance between the two major asset classes – equity and debt.
An STP can be of three types: A fixed STP is one in which a fixed amount in transferred from one scheme to another. A capital appreciation STP is one in which only the profits of one scheme are transferred to the other. Meanwhile, a flexi STP is one in which an investor can choose to transfer an amount that is variable. This variable amount depends upon market volatility.
Comparing SIP And STP
An STP functions like an SIP itself. This is so because it entails periodically deploying a certain number of units or money into a scheme – the same thing that is done by an SIP. Alike SIP, STP also helps in rupee cost averaging. Further, it assists an investor in rebalancing his portfolio as he can choose to switch between two funds investing in different asset classes. The facility also functions as an efficient risk mitigation strategy. It does so by making periodic investments either from or to a risky asset class, thus not exposing the entire investment to market fluctuations.
Apart from the benefits of SIP detailed earlier, it helps an investor start small. He does not have to make a large commitment upfront and can test how mutual funds work and how they benefit his portfolio. Even if an investor does not have much to spare for investments early in his career, he can choose a SIP and start making investments for as low as Rs 500 (in some cases even lower). In this manner, one can start their investment journey earlier than they otherwise would.
Both these facilities are useful in their way. However, while SIP helps one start out on investment early, STP helps them create a balance to their portfolio, and thus is more useful when one has a sizable corpus. After a certain time, both can be used in combination to provide a boost to one’s portfolio. To know more about SIP and mutual fund investments click here.
