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I won’t keep all eggs in one basket

Author: Balaji Rao/Sunday, January 7, 2018/Categories: Cover Feature, Expert View

I won’t keep all eggs in one basket

There are a lot of similarities between the mutual funds and smartphones; surprised? Most of us who use smartphones are not as smart as the smartphone itself, because we either are not aware of all the utilities available or we do not know how to benefit from all the facilities given. Mutual funds too have so many investing possibilities that many investors are not aware of. 

Apart from investing through lump sum or one time investment method, there are other opportunities too by way of SIP (Systematic Investment Plan), STP (Systematic Transfer Plan) and SWP (Systematic Withdrawal Plan) besides DTP (Dividend Transfer Plan) and rebalancing or switching from scheme to scheme based on market swings.  

SIP Dynamics

Investing through Systematic Investment Plans or SIPs is a popular way of participating in the equity market, without bothering about the timing of  entry. SIP works on the rationale of “rupee-cost averaging” wherein the monthly investment would allow the investor to buy more or less units depending on the market conditions.; While more units will be bought during bearish market trend, less units will accumulate during bullish trends. Over longer period of investing, this method helps in accumulating units that can be sold redeemed to meet the objective of investing.

Those who are completely new to understanding the dynamics of how SIP, can  , digest the concept from this simple day-to-day example. The prices of onion and tomato keeps fluctuating every day and we have witnessed prices touching as high as Rs. .100 per kilo and comeing down to as low as Rs. .20 per kilo. What would a homemaker do to beat such volatility? Simple. She buys less quantity of these vegetables when the prices are ruling high and would buy more when the prices are ruling low. This way, she manages the kitchen deftly and that’s how precisely rupee-cost averaging works in mutual funds.

During an SIP tenure spanning, let’s say over 5 years, the NAV of an equity scheme fluctuates.Based on the prevailing NAV on a given day, the pre-determined investment amount (say, Rs..1,000) would be buying different units over the next 60 months. Each  month of purchase assists in allotment of specific units based on the day’s prevailing NAV. Addition of those accumulated units over the chosen tenure could be valued at the NAV price on the closing day of which is usually higher offering compounded returns on the total investment. Similar example can be considered for SIPs with tenures exceeding 5 years. In the below table, a sample of one year real-time SIP performance has been given for easy understanding of the concept. 

SIP is similar to recurring deposit (RD) concept and is suitable for individuals who would like to plan for their long term goals by investing small amounts each month for higher returns, which can overcome inflation and  create a desired corpus. SIP is a time tested investment method with empirical evidences suggesting that over a longer period of investing, the returns are worth the effort and risk. 

STP Dynamics

The other lesser known opportunities are Systematic Transfer Plan (STP) and Systematic Withdrawal Plan (SWP). While SIP works on the concept of bringing fresh money each month, STP works on the concept of transferring fixed amount of money for a fixed period of time after certain time period. 

Let’s see, how STP works through an example.: Neha, a young investor has a lump sum amount of Rs.1.00 lakh which she intends to invest in stock markets through mutual fund route. ; As per her expectations, she foresees the market to be bearish in the coming months. Hence, the moment she does not want to invest fully in an equity scheme, but would like to participate in a systematic manner,. she chooses a debt mutual fund scheme (For example,: a liquid fund) of a particular fund house and invests Rs.1.00 lakh instructing the fund house to transfer Rs.8,333 each month to a pre-decided equity mutual fund within the same fund house for a period of 12 months. 

As can be seen from Part 1  & 2, a fixed amount gets transferred from a debt fund to an equity fund every month on a particular date, for 12 months. The amount invested in the debt fund will continue to earn the basic return (range of returns of a typical liquid fund as on Dec 2017 is 6% to 7% p.a.), while the predetermined amount will get transferred on the fixed date over 12 months into a specific equity scheme. Upon transfer of the amount, the fund house would allot units based on the prevailing NAV. month after month. At the same time, the amount from the liquid fund would go on reducing in line with such transfers.

In Part-2, it can be seen that for the first few months, the NAV has dropped and gradually picked-up in line with the prediction of the investor. At the end of 12 months, the value comes out to be Rs.1.15 lakh plus the nominal returns earned from liquid fund which  is  quite impressive. It has to be noted that the assumption here is that the equity market will be bearish in the given period of time and the investor will be able to get more units in those ensuing months. Once the market recovers and turns bullish, the NAV will go up helping him to redeem units at a profit.

Caveat before investing in STP

The risk in case of STP is that if the market does not fall as expected or predicted by the investor, he will get lower units as the NAVs of the equity scheme chosen would be higher. Later, if the market falls, the selling power would go down making this strategy falling flat. So, investors need to have a good understanding of the market behaviour before choosing STP as an entry option. But, for longer duration of investment, such market fluctuations may benefit the investor.

SWP Dynamics

The other cousin of SIP and STP is SWP or Systematic Withdrawal Plan. This ideally suits an individual who has lump sum to invest and expects regular income; like a retired person. Apart from investing in FDs and other post office savings instruments like MIS (monthly income scheme), if an individual has the ability for taking market risk and looks to generate steady monthly income apart from higher returns, then SWP could be the answer.

Here, a lump sum amount is invested in an equity scheme and a fixed monthly withdrawal amount is determined. Let’s discuss the same with an example.: Raghavan retired from his service and has funds worth Rs 40 lakh from which he expects to generate monthly income of about Rs 25,000; the following option can be considered:
Rs  30.00 lakhs is invested in a fixed deposit that generates post-tax return of 6.50% under senior citizen deposit scheme and; the monthly income coming from this source would be around Rs  16,000. The balance of Rs 10 lakh can be invested in a Systematic Withdrawal Plan in an equity mutual fund (preferably in a large cap or balanced or multi-cap oriented theme) with a standing instruction to withdraw Rs 10,000 each month over a period of 100 months (Rs 10 lakhs / Rs 10000). 

SWP offers a good opportunity to generate compounded return on investment after all the withdrawals are done (based on empirical evidences across different types of themes/schemes); but one has to note that the amount withdrawn from equity scheme immediately after the investment could attract short-term capital gain taxes since it leads to withdrawing units before one year from the date of investment. Hence, it may be ideal to stay invested under the option for 12 months and then start the withdrawals which could save significant amount of tax outflow.

DTP Dynamics

Just like a post office savings scheme, which offers transfer of interest received from MIS schemes into a recurring deposit account resulting in higher return at the time of maturity, mutual funds too offers this investment option. If an investment is originally done in a debt scheme under the dividend option, the amount received from dividends can be instructed to be transferred into an equity scheme, which will generate higher return over the chosen period of time. This is typically termed as Dividend Transfer Plan or DTP which can be explored.

Financially prosperous 2018

As mutual funds are “for all seasons and for all reasons” it would be a prudent idea to explore all the possibilities that are available in this space and convert them into opportunities based on various needs of life. Every new year not only brings new hopes and expectations for a better life, it also offers an opportunity to learn a few things on the financial readiness front which could auger well for a greater financial health.

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Balaji Rao
Balaji  Rao

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