It’s advisable to adopt the twin strategy of Systematic Investment Plan (SIP) and Systematic Withdrawal Plan (SWP) to meet financial goals.
The importance of financial planning is often perceived only during an unforeseen event or after retirement when cash flow dries up. A financial plan can help you make sound financial decisions and keep you on track in achieving long-term and short-term financial goals in life. A good financial plan balances your everyday needs against your goals and deals with the present as well as the future; and Mutual Fund investments can certainly bring in that discipline of financial planning and help in building an admirable corpus.
It’s advisable to adopt the twin strategy of Systematic Investment Plan (SIP) and Systematic Withdrawal Plan (SWP) to meet financial goals. Systematic investment plan allows you to invest small amounts of money over a period of time to construct a larger corpus and bring discipline to investing; while systematic withdrawal plan gives you the freedom to enjoy the life you have always wanted and meet your financial needs when required. You can withdraw money from your existing mutual fund investments at pre-determined intervals to generate a regular cash flow for meeting your requirements. Accordingly, individuals making retirement planning are often seen opting for Systematic Withdrawal Plan to increase post-retirement income levels.
A Win-Win Situation – SIP & SWP
The twin strategy of SIP and SWP is suitable for people who are looking for a fixed flow of income for meeting their monthly financial requirements. The twin approach can help you to meet various short-term and long-term monetary needs of yours and family members like financing higher education, paying equated monthly installment (EMI) for consumer durables, house renovation, dealing with medical emergencies, meeting unexpected employment situation, post retirement earnings, and others.
Investing in SIP is best advised for accomplishing financial objectives over a period of time, because when an investor attempts to time the market, he usually misses out on the rally or enters the market at the wrong time – either the valuations have peaked or the markets are on the verge of declining. Investing every month ensures that one is invested during the peaks and valleys of the market.
SWP gives you the potential to earn more returns over a period, as you withdraw happiness bit by bit. It allows the investor a certain level of independence from market instability and helps in avoiding market timing. The investor can use the redeemed amount as a source of regular income, through a tax-efficient way while making inflation beating returns.
Let’s take an interesting example of approaching the twin strategy of SIP and SWP in meeting financial goals.
- An individual investor had a SIP of Rs 20,000 per month in a diversified equity mutual fund, which he was investing for past 10 years, this facilitated him to accumulate a strong corpus of Rs 55.73 lakh (assuming 15 percent rate of return).
- He decided to take one-year of sabbatical due to unavoidable circumstances in his employment. He needed Rs 30,000 a month to meet his overhead expenses and other financial commitments.
- After the individual investor withdrew Rs 30,000 per month, over the period of twelve months amounting Rs 3.60 lakh, his portfolio value should have come down to Rs 52.13 lakh, from Rs 55.73 lakh earlier, however, due to power of compounding earnings, the effective value of mutual fund portfolio stood at Rs 59.95 lakh (assuming 15 percent rate of return). The device of SWP, when properly used, can support a flexible and tax efficient way of maintaining a corpus while enjoying a predictable cash flow as compared to other conventional medium of investments.
The Twin Strategy Outsmarts Traditional Investments
Today traditional investment options like fixed deposits and others are witnessing a decline in interest rates. Hence, it make more sense to look out for investment avenues such as mutual funds that tide over inflation and are tax efficient compared to bank fixed deposits. Mutual funds also have high liquidity contrary to fixed deposits that are bound by the tenure. Let’s take a thought-provoking illustration of mutual funds scoring over fixed deposits.
- If an individual investor considers a SIP of Rs 25,000 per month in diversified equity mutual fund for 10 years, assuming 15 percent rate of return; then this persistent investment process will reward a strong corpus worth Rs 69.66 lakh over the same period.
- However, if an individual investor make investment in a fixed deposit or recurring deposit of Rs 25,000 per month in a recognized bank for 10 years, assuming 7.5 percent rate of return; then this investment method will build-up a corpus worth Rs 44.76 lakh, which will also be subject to income tax, based on investor earnings bracket. Hence, this make returns from SIP of a mutual fund much more attractive compared to fixed deposit or recurring deposit.
Investors should, however, remember that SWP works wonders when the corpus is substantial, hence, there should always be an endeavour for making a larger financial corpus for maximum benefits and paybacks. Let’s take an interesting example of rewards from larger financial corpus.
- An individual investor had been investing in a SIP of Rs 30,000 per month in diversified equity mutual fund for 10 years, assuming 15 percent rate of return; this will facilitate him to accumulate a strong corpus of Rs 83.59 lakh, where he can easily consider withdrawing Rs 40,000 per month though SWP for a sustained period.
- However, if an individual investor considers a SIP of only Rs 5,000 per month in diversified equity mutual fund for 10 years, assuming 15 percent rate of return; then his corpus will merely worth Rs 13.93 lakh, this will limit the capacity of the investor to withdraw a meaningful amount over a longer period. Hence, investors should construct strong financial corpus for realizing higher benefits or paybacks.
The twin strategy of SIP and SWP can aid you in making sound financial plan and keep you on path in accomplishing your financial objectives. The twin strategy can bring equilibrium to your everyday financial requirements alongside achieving your long-term monetary goals; while you benefit from the power of compounding, rupee cost of averaging, inflation beating returns, and gaining tax efficiency while investing – Mutual Funds Sahi Hai !
The writer is MD & CEO of SBI Mutual Fund
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