If you are a regular mutual fund investor, it is essential to build your portfolio strategically. Many investors buy mutual fund units when valuations are high. Unfortunately, this often lowers their overall returns.
To avoid this, it is recommended to buy mutual fund units at different price points. This “averages out” your purchase cost. The most effective way to do this is through a Systematic Investment Plan (SIP).
How do SIPs help maximise your returns?
For the uninitiated, SIP is a mandate given to the Mutual Fund (MF) house to deduct a certain sum from your bank account and invest it in a specific scheme at regular intervals, i.e., every month or every week, etc.
Let us understand this with the help of an example. Suppose you want to invest ₹5 lakh in a mid-cap scheme of a fund house and are warned by your wealth advisor to stay away from mid-cap stocks for the current month because of their high valuation. But you don’t want to miss the future upside either.
Solution? Investing in mid-cap funds via small tranches, i.e., SIPs. These small investment plans will help you get exposure to your preferred mutual fund (mid-cap or small-cap) without risking entering at the ‘wrong time’.
“Trying to time the market is not what allows you to create long-term wealth, whereas it’s how much time you were invested in the market. So, one should focus on being invested for as long as possible. And the best way to do this is through an SIP,” says Preeti Zende, Founder of Apna Dhan Financial Services.
Impact on capital gains tax
To compute capital gains tax on mutual funds acquired through SIPs, one needs to understand the FIFO (first-in, first-out) principle. This means that the mutual fund units bought first are redeemed first. In other words, the units that are purchased first are believed to have been sold first.
Following this, one can calculate the capital gains tax (short-term or long-term, as applicable). For equity mutual funds, long-term capital gains tax applies when the sale date is after 12 months. For non-equity funds, LTCG applies when the sale date is after 24 months.
How do the STPs play out?
Similar to SIP, a systematic transfer plan (STP) allows you to park your money in a temporary fund until you manage to transfer the proceeds of this fund to the destination fund.
For example, you plan to invest ₹5 lakh in a small-cap fund, but since small caps are overpriced currently, you want to go via the SIP route over the next 10 months. So, you will invest ₹50,000 every month.
But what about the interim 10 months. Either you invest your funds in an FD during this period, or you invest in a debt mutual fund that offers 7 to 8% a year and gradually move the funds to a small-cap mutual fund. The route that facilitates this transfer is known as systematic transfer plan (STP).
So, the best way forward for a retail investor is to marry SIPs with STPs so that not only does he average out the cost of acquisition of his preferred asset but he also makes the most of his money by earning a healthy return on it during the interim period.
Always remember that the ‘right planning’ and ‘disciplined investing’ are crucial pillars of long-term wealth creation.
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