How to create wealth using mutual fund SIPs She declines support from her parents for all her life goals. Riya anticipates various life milestones but her biggest worry is retirement, as she wonders whether she will be able to manage her finances without a steady monthly income
At 27, Riya wants to plan her finances meticulously now that she has a stable career. She has been leading a financially independent life for the past four years. She declines support from her parents for all her life goals. Riya anticipates various life milestones but her biggest worry is retirement, as she wonders whether she will be able to manage her finances without a steady monthly income. She wants to ensure that she saves enough to cover her future needs, plus a sizeable corpus to generate a reliable monthly cash flow. She currently invests solely in equityoriented mutual fund schemes because she feels she lacks the expertise for active investment monitoring.Riya’s financial journey can be likened to a three-part story: wealth creation, protection, and distribution. Each part needs a different plan and investment. At this stage, her focus should be creating wealth through systematic investment plans (SIPs). SIPs will enable her to save fixed amounts at regular intervals, smoothing market volatility by purchasing more units at lower NAVs and fewer at higher ones. By investing Rs.5,000 monthly via SIPs in equity mutual funds and increasing it annually by 10% as her income rises, she could accumulate a corpus of Rs.43 lakh by age 35. She should aim to withdraw Rs.30 lakh to make a down payment on a house, another Rs.50 lakh to fund her luxury car at 50 years, another Rs.50 lakh to fund her child’s education at 58 years and still be able to retire with Rs.5.5 crore at 60. That’s what the power of compounding of a small monthly amount can achieve over a long period of time!
Before approaching every major financial goal, such as house, luxury car or her child’s education, she should transfer units worth the required amount from her portfolio of equity mutual funds to a less volatile debt mutual fund in order to protect her corpus from any major downside event. For a requirement of Rs.30 lakh, she could set up a systematic transfer plan (STP) one year in advance, transferring Rs.2.5 lakh each month. This would allow her to continue earning relatively higher equity returns on the remaining balance while safeguarding the accumulated wealth from any sudden market fluctuations. Besides, she will earn a higher return than her savings account and enjoy the benefits of an SIP, smoothing out market fluctuations. Similarly, before approaching retirement at 60 years, she might want to transition from equity mutual funds to debt-oriented mutual funds, such as corporate bond funds and conservative hybrid funds, which offer relative stability with lower volatility.
On retirement, Riya can use systematic withdrawal plans (SWPs) to generate a steady cash flow, replacing her monthly income. With SWPs, a fixed amount is redeemed from her mutual funds and credited to her bank account according to her chosen frequency and duration.
Hence, we can assert that while SIP is a tool for wealth creation, STP serves as a means for wealth preservation, and SWP for wealth distribution. Effective utilisation of these three unique facilities offered by mutual funds could be the secret of Riya’s financial freedom.
Content on this page is courtesy Centre for Investment Education and Learning (CIEL).
Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.
(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)
This story originally appeared on: India Times - Author:Faqs of Insurances
