Two strategies to fulfil any investment goal
Systematic investment and withdrawal plans can help build a corpus over the long-term and ensure regular cash flow while your kitty continues to grow
At a time when interest rates paid on traditional investment options like fixed deposits are declining, investors need to consider investing in equity mutual funds to be able to meet their long-term goals. Not only can equity mutual funds offer them better returns over the long-term, but they are also more tax efficient compared to traditional savings instruments.
Mutual funds also offer higher liquidity compared to fixed deposits. If you invest in the latter, you end up paying a price if you withdraw your money before the completion of its tenure.
If a retail investor puts ~25,000 a month in a diversified equity mutual fund for 10 years, he will build a corpus of ~69.66 lakh, assuming an average return of 15 per cent a year. If the same investor puts his money in a fixed deposit (FD) or recurring deposit (RD) of ~25,000 a month in a recognised bank for 10 years, he will end up with a corpus of only ~44.76 lakh, at an interest rate of 7.5 per cent. While the entire capital gains earned on the mutual fund would be tax-free, the investor would have to pay tax on his gains in an FD or RD, at a rate determined by his income tax slab. Twin strategies introduce discipline Most individuals understand the significance of financial planning only when an unforeseen event occurs and drains their savings, or after retirement, when their regular income dries up. Building a sizeable corpus, however, is not difficult. All it requires is discipline. Once you have done the desired savings, you need to focus on sustaining your wealth. To build and maintain a corpus, all you need are two simple strategies — a systematic investment plan (SIP) and a systematic withdrawal plan (SWP).
An SIP allows you to invest small amounts of money over a period to construct a large corpus. It brings discipline to investing. An SWP lets you withdraw money from your existing mutual fund investments at predetermined intervals to generate a regular cash flow for meeting your requirements. A win-win situation The twin approach can help you meet various short-term and longterm monetary needs like financing your children’s higher education, paying equated monthly instalments for loans, house renovation, dealing with medical emergencies, dealing with unexpected retrenchment at the workplace, post-retirement earnings, and so on.
When an investor attempts to time the market, he usually misses out on the rally and enters the market at the wrong time — when valuations have peaked and the markets are poised for a downturn. Investing every month using an SIP ensures that an individual is invested both during the peaks and the downturns.
An SWP lets you withdraw a part of your corpus at regular intervals while ensuring the balance that is still invested keeps growing. As an investor withdraws the funds bit by bit, it allows him a certain level of independence from the market instability and helps in avoiding the risk of market timing. The investor can use the redeemed amount as a source of regular income in a taxefficient way while still earning inflation-beating returns.
Assume that an individual invests ~20,000 a month in a diversified equity mutual fund using an SIP. He does this for 10 years without missing a single investment. In a decade, he creates a corpus of ~55.73 lakh, assuming that his fund earns an average return of 15 per cent a year. Due to unavoidable circumstances in his employment, he is forced to take a sabbatical for one year. To meet his expenses and other financial commitments, he needs ~30,000 a month. He, therefore, opts for an SWP of 12 months. After withdrawing ~3.6 lakh in a year, one would think that his investment would come down to ~52.13 lakh. But as he is using an SWP, his corpus keeps growing despite the monthly withdrawals. At the end of the year, he would still have a corpus of ~59.95 lakh (assuming a 15 per cent rate of return for the year). That’s the power of compounding.
If SWP is used correctly, it can support a flexible and tax-efficient way of maintaining a corpus, while enjoying a predictable cash flow. This is a much better option than investing in other traditional fixedincome products. Build an adequate corpus SWP works wonders only if an investor has a substantial corpus. Hence, one should always endeavour to build a large financial corpus for maximum benefits and paybacks. The bigger the corpus, the more effectively the SWP will work for you in retirement.
Assume that a retiree invests ~30,000 a month in a diversified equity mutual fund for 10 years. On retirement, he accumulates ~83.59 lakh (at a 15 per cent annualised rate of return). He can use an SWP to have a monthly cash flow of ~40,000, while his money continues to grow. But if he saves only ~5,000 a month, then his corpus at retirement would be merely worth ~13.93 lakh. He would not be able to accumulate a meaningful corpus by investing such a small amount. An investor should, therefore, focus on building a large enough kitty that can serve him throughout his retired life.
The twin strategies can help you accomplish your financial objectives. They can bring equilibrium to your everyday financial life — you spend some and you save some during your work life — while helping you accomplish your longterm monetary goals. At the same time, you benefit from the power of compounding, rupee-cost averaging, earn inflation-beating returns and enjoy maximum tax efficiency.