SIP, STP & SWP

SIP, STP and SWP

These are terms associated with the Mutual Fund industry.

SIP stands for Systematic Investment Plan,

STP stands for Systematic Transfer Plan and

SWP stands for Systematic Withdrawal Plan

 

 

The expansion of these terms makes definition of these terms quite self-explanatory. However how each of these work & the purpose for which these are used are different.

 

 SIP - Systematic Investment Plan. This is the most popular and most widely used of these 3 terms. SIP is very similar to a bank recurring deposits. In Recurring Deposit, a fixed sum of money is invested every month on a specific day and is cumulated for a pre-determined  period, normally in multiple of 12 months. At the end of this period the cumulated amount along with a pre-determined interest is repaid to the investor.

A person investing in SIP similarly sets aside a fixed amount every month which is invested in a mutual fund scheme. There is no pre-determined period as in RD. There is no pre-determined return. Normally SIP is used to invest in an equity mutual fund scheme. Equity as is its inherent nature does not give a fixed return. Equity markets tend to be volatile in the short term. But in the long-term equity has proved to be the best asset class in terms of returns. Therefore, a SIP investment in an equity mutual fund scheme should be for a long period, preferably 5 years or more. The idea behind investing in equity through SIP, is that it irons out the volatility of the equity market. By setting aside an equal amount every month one tends to buy more when the markets are low and buy less when the markets are high leading to what is popularly called as “Dollar Cost Averaging”. By following this strategy an investor can reduce the impact of volatility.

The purpose of SIP (in an equity fund) is to accumulate a corpus for a goal which is well into the future by averaging and taking advantage of high returns. There will be no tax outgo at the time of investing via SIP.

 

STP - Systematic Transfer Plan. This is small variation of SIP. This is best explained with the help of an example. Suppose a person gets a windfall of a lump sum of money, say a lottery or inheritance or retirement proceeds. He wishes to have a portion of this invested in an asset class the price of which tends to be volatile, say gold or equity. If this investor invests the bulk of the money in a debt instrument and transfers a fixed portion regularly from the debt instrument to the targeted asset class (where he ultimately wishes to invest) over a period of time say one year, he is said to have resorted to STP to transfer from debt to equity or gold. The advantage is that the amount does not get invested in the target asset class in one go, but the investing cost gets averaged out over a year.

The purpose of STP is to transfer bulk amount to a volatile asset class over a period of time without having to do it in a single shot.

Investor has to check the tax implication in respect of the amount withdrawn from the initial (normally debt) asset class.

 

SWP - Systematic Withdrawal Plan. As the name suggests, in SWP the investor withdraws a fixed amount at a fixed interval from a corpus. Whereas in a SIP/STP the amount ultimately gets invested in an asset class thereby creating a corpus, in SWP the corpus gets reduced as the investor withdraws amount from the investment created. This is normally resorted to by retirees who are in requirement of a regular source of cash for their routine requirements.

The purpose of a SWP is to create a positive cash flow to the investor.

Investor has to check the tax implication in respect of the amount withdrawn.

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Assets, Liabilities, Income, Expenditure

Assets, Liabilities, Income, Expenditure – These are the most common terms one comes across frequently when dealing with Finance. These four form the pillars of Personal Finance. 

 

Why these are pillars? All transactions (in money or money’s worth) that happen fall under one of these four categories.

Why is it important? A payment for purchase of a motor car would be an asset where as payment for fuel for the vehicle would be an expense. Similarly, a deposit received for letting out an apartment is a liability but the rent received for letting out the same apartment is an income. It is therefore important to identify & distinguish the nature of payments & receipts.

 

Assets 

 

 In simple words you can call something an asset if it gives you a benefit over a long period of time, normally more than a year. A sofa set at your home, an apartment which you own, would qualify as assets. Also, any amount which you expect to get in future (invoice raised on client by a business, but amount still outstanding) or any amount given to someone which is returnable (Bank FD, loan to friend, excess tax paid to Government) also qualify as an asset. Similarly, any amount invested by a businessman in his own business as a proprietor or as a partner would also be an asset. There are certain assets which are intangible. Example goodwill.

Assets are broadly categorised into Current Assets, Fixed Assets & Investments. As per this categorisation cash in hand, cash at bank and any asset due for realisation within one year would be Current Assets. Any financial Asset would be an Investment. And assets such as apartment, vehicle, furniture, etc would be Fixed Assets.

In the case of businesses, as a matter of standardisation and in some cases as required by law, assets can be grouped into:

Fixed Assets comprising of: Immovable Assets (land, building, shop, apartment, etc), & Movable Assets (furniture, equipment, vehicle, jewellery, etc), Intangible Assets (Goodwill, patent, copyright)

Investments (Bank deposits, shares, mutual funds, investment in business)

Loan & Advances (Loan to friend, tax refund due, advance paid to builder to buy an apartment)

Current Assets - Includes cash at bank, cash in hand, & any other asset that is realisable within one year

Others – Residual category

 

Liabilities

 A liability is a debt or an obligation which a person owes to another. In accounting language, a liability is opposite of an asset. For instance, a bank deposit is an asset for an investor, but the same deposit becomes a liability for the bank, because the bank has to repay the depositor the deposit amount after the tenure of the deposit. Similarly, a loan taken from any one (including a bank), amount due to a supplier of an item which is outstanding, salary or any other expenses such as electricity, telephone bill, etc payable by a business organisation at the end of the month, taxes due to the government, would all be liabilities.

For a business organisation, amount invested by the owners of the business such as proprietor, partners, shareholders, etc would be liabilities. Also, since the profit earned by the business, after paying of all expenses & taxes, would also belong to the owners, hence liability to the business.

As a matter of standardisation and sometimes as required by law, liabilities can be grouped into:

Owners’ Funds (Equity capital, Reserves, etc)

Secured & Unsecured Loans (loans taken from banks, financial institutions & others)

Current Liabilities (amount due to suppliers, expenses payable, etc)

 

Income 

 The word income is normally associated with the word earn. Any receipt of money or money’s equal that is earned is income.

As per the primary laws of economics all income would fit into one of the four categories - Profit, Wage/Salary, Interest or Rent.

Profit means any earning made out of investment made in business. It would include profit earned by a sole proprietary business person, share of profit from a partnership firm. If one treats shareholding in a company as owning a part of that business, dividend earned out of that could be categorised as profit. Normally profit is not fixed & tends to vary from period to period.

Wage / Salary means any earning made in return for physical & mental input. Daily earning by a migrant worker / farm worker, a weekly earning by a factory worker, a software engineer’s monthly salary would fall under the head Salary / Wage. Wage would include any receipt linked to a person’s Wage / Salary such as allowance, Leave Salary, Gratuity, Pension, Family Pension. Earnings by a professional such as lawyer, doctor or an architect too would fall under the category of salary / wages.

Interest is any earning derived out of sum of money given to another for the use of such sum of money by the other person. Any amount received as compensation from a bank or finance company for deposit placed with them, from a friend for a loan given to them, from corporations or governments for Bonds issued by them, would all be interest income.

Rent is any earning derived when one lets out ones property to another for a limited purpose whether regularly or on a one time basis. I can let out an apartment I own to a friend who requires it for 3 months and he agrees to compensate for the use by paying me a rent. Or if you have friends visiting you for a week you can rent a vehicle for taking them out by paying the car rental company. A person can rent an oxygen cylinder if he has got a medical condition and is not sure whether it would work for him.

 

Expenditure

The word expenditure is associated with the word incur. Having understood income, it is much easier to understand expenditure. An expenditure is an exact opposite of an income. Technically, any outflow of money or money’s worth that does not have any lasting benefit and that which does not reduce any liability is an expense. So fuel expenses for a vehicle, rent paid for occupying an apartment or office, utility expenses such as electricity & water charges, any expense incurred by a business person on their staff including salaries, staff welfare, etc., children’s education fees paid would all be classified as expenditure.

Expenses can be fixed or variable expenses. Specific amount paid regularly by way of rent or regular salary paid to staff by a business man and such similar expenses which more or less remain constant irrespective of the situation, would be fixed expenses whereas fuel for vehicle (which would depend on the usage of the vehicle),  or any such expenses that does not remain constant over a period of time would be variable expenses.

Expenses can also be classified as cash expenses & non cash expenses. A very good example of non-cash expense would be depreciation or amortisation. When an equipment is purchased, the effective life of the equipment is estimated. The scrap value of the equipment at the end of the life is also estimated. The difference between the cost & scrap value is spread over the life of the equipment and written off as an expense. This write off is called depreciation or amortisation. Cash outflow is incurred only once, at the time of purchase of the equipment, but the expense is incurred proportionately over a period of the life time of the asset, hence non-cash expenses.

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Classes of Assets, Asset Allocation & Importance of Asset Allocation

An eight month old baby, a growing child, a middle aged worker & a seventy year old person would all define their ideal diet in different ways. A diet suitable to a growing child could bring indigestion to an eight month old baby, similarly a diet of an old person would not give sufficient nutrition to a middle aged worker. If such a basic part of one’s living, diet, is different for different persons to suit the physical health of that person, so is the investment strategy (how an investor’s portfolio is invested across different asset classes) for different types of people to suit the financial health of that person.

In this context we have a look at what different asset classes are, what asset allocation is & what is the importance of having a proper asset allocation.

 

 

 

Asset Classes & their characteristics

Common asset classes that form part of an average investor’s portfolio consist of Equity, Debt, Real Estate & Gold.

 

Equity refers to ownership. Returns from investment in equity depends on the profitability of an enterprise. And profitability of an enterprise cannot be predicted. However successful enterprises make good profits over a longer period of time. So an investment in equity would have too much volatility in the short run, but robust return in the long run. Hence an investment in equity is ideal for beating inflation in the long run. Common examples are equity shares, equity mutual funds and the more esoteric equity PMS, foreign equity holdings and variations thereof.

 

 

Debt refers to what one lends to another. Return from investment in debt has no connection with the profitability of an enterprise. An enterprise normally uses borrowing as a substitute to owner’s equity. A person who lends this amount gets fixed interest on the amount so lent. Thus an investment in debt would fetch one a fixed return at periodical intervals. It is therefore ideal for a person who requires fixed income or whose goals are short term where he can not afford to have the uncertainty  of return from equity. Thus a debt investment is ideal in the short run to take care of short term and medium term goals but not suitable to beat inflation in the long run This could be either in Government or private sectors. Common examples are Bank FDs, Corporate Deposits, Debentures, Post Office Savings, Provident Fund, Bond Funds, etc.

 

 

Real Estate refers to an investment in land or property. An apartment used for residing or a shop or office purchased for conducting business should not be categorised as an Asset, unless the person plans to sell it. A real estate is any property purchased with the intention of letting out on rent or selling at profit at a later date. However in case of an emergency requirement one can not sell a portion of one’s house. An investment in a physical real estate therefore has liquidity issues.  Common examples are second house, plot, shop purchased by a salaried person, the more recent types being REITs, etc.

 

 

Gold is man’s oldest and most reliable asset. It could be termed as the most liquid of assets next only to currency. However in case of investment in Gold, people tend to become emotionally attached. Return from this asset class is only when you liquidate it. It is not suitable for a person who requires periodic return. At a basic level gold could mean either gold jewellery, gold coins or gold biscuits. For a mature investor this could be gold bonds or gold ETF.

 

 

Asset Allocation

Asset Allocation refers to parking one’s total net worth in a sensible mix of assets. This mix of assets  normally consist of all the asset classes, but in different proportions depending on the investor’s background. For an asset allocation to be sensible it is important to consider several factors of which the investor’s age &  risk profile are the primary ones.

Importance of Asset Allocation

An investor’s portfolio requires proper asset allocation to ensure a right mix of growth, stability, liquidity. However these components namely growth, stability & liquidity would vary depending on the investor’s background.

This allocation is comparable with the diet of people from different age groups as we saw in the opening para of this article. 

 

 

A youngster having a regular source of income from salary or business & one who has several years remaining for his retirement should ideally have a major component invested in equity so that he gets the benefit of higher returns over a longer period though more volatile. A middle aged person who may be having kids with education expenses should have a suitable amount in readily available investment vehicles (debt). If this person has a good period of time remaining  for his retirement he should invest a portion of his net worth in equity to take the benefit of higher returns. A retired person should have a major portion in debt to ensure that he gets fixed but regular returns.

 

Sometime investors, irrespective of their age &/or risk profile, feel they are better off with one or two asset classes in their portfolio. This is mainly due to the comfort factor they feel with a particular asset class. An important reason why they may prefer to remain away from an asset class is perhaps they may not understand the same properly or may have had an unpleasant experience in investing in the same.
 

The content made available in this article is for general informational purposes only. While every effort has been made to ensure the accuracy and completeness of the content, it should not be considered as a substitute for professional consultation. 

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