SIP vs SWP vs STP: Differences and how to choose

Systematic Investment Plans (SIPs) are very popular among those seeking disciplined investments. But there are two other lesser-known tools that help in systematic investing. These are Systematic Withdrawal Plans (SWPs), and Systematic Transfer Plans (STPs) - each offering unique benefits for investors. This article will help you understand how each of these three tools works and how you can use them to reach your financial goals.

• Table of contents

1. What is SIP?
2. Benefits of SIP
3. What is SWP?
4. Benefits of SWP
5. What is STP?
6. Benefits of STP
7. Difference between SIP vs SWP vs STP

What is SIP?

A Systematic Investment Plan, commonly referred to as SIP, is an investment methodology of allocating a predetermined sum of money at regular intervals, typically monthly, into a chosen investment vehicle. This approach promotes consistent investing, regardless of market fluctuations, making it a favoured choice for individuals seeking disciplined wealth accumulation.

How it works

SIPs operate on a simple yet effective principle. An investor selects a mutual fund or other investment scheme and authorizes their bank to automatically deduct a fixed amount from their account at specified intervals. These funds are then invested in the chosen scheme, purchasing units at the prevailing Net Asset Value (NAV) on the investment date.

Benefits of SIP

SIPs are popular for these reasons:

1. Discipline: The automated nature of SIPs instils a habit of regular saving, circumventing the temptation to spend impulsively.
2. Rupee-Cost Averaging: By investing fixed amounts at varying market levels, SIPs inherently average out the cost of investments, mitigating the impact of market volatility.
3. The Power of Compounding: Over time, the returns generated by SIP investments are reinvested, leading to exponential growth through compounding.
4. Flexibility: SIPs can be initiated with relatively small amounts, and contributions can be adjusted as financial circumstances evolve.
5. Ideal for Long-Term Goals: SIPs are particularly suited for long-term financial objectives such as retirement planning, education funding, or wealth creation.

Read also: Benefits of investing in SIP for your financial goals

What is SWP?

Investors seeking a consistent income stream from their investments may find a viable solution in Systematic Withdrawal Plans (SWPs). An SWP is a mechanism within mutual funds that facilitates periodic withdrawals of a predetermined amount from an existing investment.

How it works

An SWP commences with an initial lumpsum investment in a chosen mutual fund scheme. Subsequently, the investor establishes an SWP mandate, specifying the desired withdrawal amount and frequency (monthly, quarterly, or annually). On the designated dates, the mutual fund company redeems units from the investor's holdings to fulfil the withdrawal request. The redeemed amount is then credited to the investor's bank account. The remaining units continue to participate in the market, potentially generating further growth.

Benefits of SWP

SWPs present a compelling proposition for investors seeking regular inflow of funds:

• Planned Liquidity: SWPs enable investors to systematically access their invested capital based on their liquidity requirements.
• Predictable Inflow of Funds: This approach creates a dependable source of periodic cashflow, potentially supplementing other sources of revenue or serving as a retirement income solution.
• Controlled Capital Depletion: SWPs offer a structured way to manage the drawdown of one's investment corpus, potentially extending its longevity.
• Adaptable to Needs: Investors can tailor the withdrawal amount and frequency to align with their specific financial goals and cash flow needs.

What is STP?

A Systematic Transfer Plan, or STP, is an investment strategy that facilitates the periodic transfer of a specified sum from one mutual fund scheme to another. This methodical approach enables investors to systematically shift their investments between different asset classes within the same fund house.

How it works

An STP involves the selection of two mutual fund schemes: a source scheme (typically a debt fund such as liquid fund) and a target scheme (usually an equity fund with higher growth potential or a hybrid fund). The investor then designates the transfer amount and frequency (monthly, quarterly, etc.). On the specified dates, the predetermined amount is automatically transferred from the source scheme to the target scheme, purchasing units at the prevailing NAV of the target scheme.

Benefits of STP

STPs present a number of benefits for investors:

• Mitigated Risk Exposure: STPs allow for a gradual transition of investments from lower-risk assets (debt) to higher-risk assets (equity), thereby managing risk and potential returns over time.
• Cost Averaging Advantage: Similar to SIPs, STPs benefit from rupee-cost averaging, averaging out the purchase price of units in the target scheme through regular transfers.
• Disciplined Investment Approach: The automated nature of STPs removes emotional decision-making, ensuring consistent investments regardless of market fluctuations.

Difference between SIP vs SWP vs STP

The most suitable investment strategy among SIPs, SWPs, and STPs hinges upon your unique financial circumstances and objectives. Several factors warrant careful consideration:

• Investment Time Horizon: For long-term wealth accumulation and goal attainment, SIPs and STPs are particularly well-suited. Conversely, SWPs cater to investors seeking regular income generation, making them a potential option for retirees or those requiring supplementary cash flow.
• Risk Tolerance: Investors with a lower risk appetite may find SWPs and STPs with a debt-oriented focus more appealing. On the other hand, STPs targeting equity funds and SIPs carry higher risk but also offer the prospect of greater returns.
• Financial Requirements: If your primary need is a steady income stream, SWPs emerge as the logical choice. Conversely, if your focus is on building wealth over time and achieving long-term goals, SIPs and STPs may be more aligned with your objectives.

Conclusion

Systematic Investment Plans (SIPs), Systematic Withdrawal Plans (SWPs), and Systematic Transfer Plans (STPs) are powerful tools that give you control over your investments and withdrawals with precision and efficiency. Whether accumulating wealth through disciplined investments (SIPs), generating a predictable income stream (SWPs), or strategically reallocating assets (STPs), these systematic methods offer distinct advantages. When choosing between these three strategies, consider using tools such as SIP calculator, STP calculator and SWP mutual fund calculator to understand how each option aligns with your goals. The optimal strategy ultimately depends on individual investment goals, risk tolerance, and time horizon.

FAQs:

Can you do SIP and SWP together?

While the simultaneous utilization of SIPs and SWPs within a single investment plan may seem counterintuitive, it is indeed a viable approach under certain circumstances. However, it is crucial to acknowledge certain limitations that accompany this strategy.

One notable constraint is the potential lack of flexibility. Predefined terms and conditions associated with such combined plans might restrict an investor's ability to make ad-hoc adjustments to their investment or withdrawal amounts.

Additionally, investment choices may be confined to the offerings of a specific fund house. This limitation could potentially hinder investors from accessing a wider range of schemes that might better align with their risk appetite or financial objectives.

It is imperative for investors to meticulously evaluate the associated terms and restrictions before opting for such a plan.

Is STP better than a lumpsum?

STPs are generally favoured by investors seeking a more conservative approach to entering volatile markets, while lump-sum investments may be suitable for those with a higher risk appetite and a belief in imminent market appreciation.

Systematic Transfer Plan (STP): vfSTPs provide a mechanism for gradually introducing funds into higher-risk asset classes, potentially mitigating downside risk. This phased approach can also offer potential tax advantages by spreading out capital gains over time.

Lumpsum Investment: Lumpsum investments involve deploying the entire capital at once, aiming to capture potential market upswings. However, this approach carries a higher degree of risk, as the investment is exposed to market fluctuations immediately.

What is the 4% SWP rule?

The 4% rule, a widely recognized guideline for retirement income planning, proposes an initial withdrawal rate of 4% from one's accumulated retirement savings in the first year of retirement. Subsequently, this withdrawal amount is adjusted annually to account for inflation, aiming to maintain purchasing power throughout the retirement phase.

To illustrate, consider an individual retiring with a corpus of ₹5 crore. In the initial year, they could withdraw ₹20 lakhs, representing 4% of their savings. If the inflation rate in the subsequent year stands at 5%, the withdrawal amount would be increased by the same percentage, resulting in a withdrawal of ₹21 lakhs in the second year. This process of inflation-adjusted withdrawals would continue throughout the retirement period.

What is the 8-4-3 rule in SIP?

It is a simple approach to mutual fund investing. Allocate 8% of your monthly income to a portfolio of four diversified equity funds and maintain this investment for a minimum of three years.

What are the disadvantages of SWP?

• Market Risk: SWPs are subject to market fluctuations. During periods of market downturns, withdrawals could potentially deplete the capital base faster than anticipated.
• Inflation Risk: If the withdrawal rate doesn't keep pace with inflation, the purchasing power of the income generated may erode over time.
• Longevity Risk: If the withdrawal rate is too high, there's a risk of outliving one's investments, particularly in the context of extended lifespans.
• Limited Flexibility: Some SWP plans may have restrictions on modifying withdrawal amounts or frequencies, potentially limiting adaptability to changing financial needs.

Which one is the right fit for you?

The most suitable choice among SIPs, SWPs, and STPs depends on your individual financial goals and risk tolerance.

• SIP: Ideal for long-term wealth accumulation and disciplined investing, particularly for individuals with a longer investment horizon and a willingness to embrace market volatility.
• SWP: Suited for generating regular inflow of funds, potentially beneficial for retirees or those seeking a supplementary income stream.
• STP: A strategic tool for gradually shifting investments between asset classes, potentially mitigating risk and optimizing returns over time.
   

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.