Use SWP, STP Tools Effectively for Robust Mutual Fund Portfolio

Last Updated : Aug. 22, 2016, 11:22 a.m.

Finding the safe heaven for parking your hard-earned money has got easier now with various instruments such as fixed deposits, recurring deposits, mutual funds, etc. Out of these alternatives, mutual fund emerges the best saving medium because of the avenues of higher returns along with the safety of the capital that it ensures. Well, there are many ways to put your money in mutual fund. But, the most common and popular one is Systematic Investment Plan (SIP), which allows you to invest a fixed sum of money on a periodical basis and provides substantial returns over the long-term. I guess many are familiar with the concept of SIP. However, I ponder whether investors really pay attention to Systematic Withdrawal Plan (SWP) and Systematic Transfer Plan (STP), the other mediums of mutual fund investment. So, in this article, we will brief on both the terms as well as tell you how you can maximize your gains from them.

SWP
SWP is gradually becoming the choice of investors who want a steady income from their investments on a monthly basis. SWP enables investors to withdraw a fixed sum of money from their investment on the same date of every month for a specific tenure.

Operational Methodology
For instance- Sohan has 5,000 mutual fund units and the Net Asset Value (NAV) of each unit is Rs 25, then the overall investment of Sohan comes out to be Rs 1,25,000. If Sohan seeks a monthly income of Rs 8,000 through SWP, then the number of units that he can withdraw will be 320 (8000/25). The balance 4680 units would now be available at Rs 1,17,000 (4,680×25). On withdrawal of a fixed sum of Rs 8,000 every month by Sohan, the NAV of the mutual fund units would also rise in accordance with market conditions. If the NAV rises to Rs 26.50 per unit in the second month, the number of units required to withdraw Rs 8,000 would thus reduce to 302 approximately. The balance 4378 units would then be available at Rs 1,16,017 (4378×26.50). On withdrawal of Rs 16,000 in two months, the balance should have been Rs 1,09,000. But, with SWP, the balance comes out to be Rs 1,16,017, a gain of Rs 7,017.

Types
Fixed Withdrawal- With fixed withdrawal variant, you can withdraw a fixed sum of money at predetermined intervals. You can withdraw a sum of say Rs 5,000 from an investment of Rs 3 lakhs each month.

Appreciation Withdrawal- With this variant, one can withdraw only on the overall appreciation value of the actual fund. For example-If you have made an investment of Rs 5 lakhs and enjoy a return of 10%, then the withdrawal will be allowed only on Rs 50,000, with the capital invested being kept intact.

Advantages

• Firstly, no tax is deducted at source with SWP. Secondly, your overall tax liability reduces significantly compared to a dividend scheme, which attracts Dividend Distribution Tax (DDT) ranging from 12.5% to 25% across different mutual fund categories such as balanced funds, debt funds, liquid funds, money market funds. Profit earned by selling of mutual fund units via SWP attracts tax rate of 10% without indexation and 20% with indexation. Indexation helps adjust the purchase price of the mutual fund units as per the prevailing inflation in the market. Buoyed by the dose of indexation, the tax liability here will be much lower than the interest earned on fixed deposits of banks.
• SWP can be of a great help for investors who want a fixed monthly income from their investments. Senior citizens can avail this scheme to their advantage by using it to get a fixed sum of money each month from their investment instead of depending on dividends that can change as per the varying market conditions.
• SWPs enable inflationary corrections, which means that the funds normally generate more returns on the rise in inflation. This will help effectively deal with the inflationary pressure.
• Being highly liquid in nature, SWPs allow you to withdraw a large sum of money whenever required. You can sell off some units to raise the much needed funds for you.

Factors to be Kept in Mind

Sizeable Corpus

You must have a reasonably higher amount so that you can withdraw the money regularly for the time you wish to. In this regard, it is important you do not withdraw the amount after a month of your investment. This will not allow your capital to grow and also reduce your capacity to withdraw the amount that you may want to. So, you are required to keep investing for a year or two and then withdraw the amount on a regular basis.

Exit Load
Keep an eye on the exit loads before you withdraw the money. Often withdrawal before a year leads to exit load, charged at 1%-2% of the withdrawal amount. So, make sure when you start withdrawing, the exit loads are not applicable so that you can withdraw and save on the charges at the same time.
After gaining information on SWP, let's shift our focus to STP.

STP
With STP, you can transfer the investment regularly from one scheme to another, primarily from a debt scheme to equity within the Asset Management Company (AMC). There are two types of STP- Fixed STP and Capital Appreciation. In the case of Fixed STP, investors can transfer a fixed sum of money from one asset class to another, while capital appreciation STP allows one to transfer the portion of profit from one asset and invest it in another instrument.

Working Methodology
Let us understand the operation of STP with the help of an example. If you have made an investment of Rs 8 lacs in debt funds and the market is trading close to the peak level. The PE ratio of the BSE and NSE is 20.54 and 23.71 (As on Aug 19, 2016), respectively. You think that the market is about to fall and start contemplating to transfer your investments from debt to equity. But, the weak sentiments could drag down the market further, leaving you in a spot of bother as the value of your investment can fall rapidly. The solution to this problem is the use of STP by which you can withdraw a specific portion from the debt schemes and put the same in equity fund. You can continue this practice for a certain time period as per your wish. It actually acts as a defence mechanism to fight against the adverse market movement.

However, you need to take some factors into consideration while opting for STP. Check out the factors mentioned below.

Large Sum Required for Equity Investment

You are required to have a large sum ready to invest in equity funds for the long-term. It works parallel to SIP where you have to invest a fixed sum of money each month from your savings account to the equity scheme. Whereas STP allows you to transfer money mostly from liquid fund, a type of debt fund, to equity fund. However, in order to get the most out of STP, you need a significantly higher corpus so that you can earn better returns than from your savings account, despite the fact that you transfer the money gradually in the market. The concept also works well when you want to shift your investment gradually from high-risk assets such as equity to low-risk propositions like debt schemes.

Keep an Eye on Taxes & Exit Loads
As STP involves the sale of the fund you are getting out of, there arises the capital gain tax and exit loads. So, it will be fruitful if you use the STP plan when there won't be any exit load applicable. Typically, exit loads are charged when you redeem the investment within a year. Whereas, capital gain tax for debt funds is charged according to the income tax slab of the individual. However, there is a benefit of indexation, a concept which has been briefed earlier.

This was all about SWP and STP. Use these tools effectively to let your mutual fund investment stay afloat in the times of adversity.