Three standing-instruction products dominate Indian retail investing, and each is a formula plus a tax consequence.
How does a SIP work?
A systematic investment plan buys a fixed rupee amount at each interval. Its future value is the ordinary annuity formula, applied at the effective rate for the interval. For a monthly plan, the monthly rate is i = (1 + R)^(1/12) − 1 where R is the annual net return, and the future value of n end-of-month contributions of P is P × [(1 + i)^*n* − 1] ÷ i. Using the annual rate divided by twelve overstates the answer, because it ignores that the twelve monthly credits themselves compound. On the ten-year, ₹15,000-a-month direct-plan case, the effective monthly rate is 0.826386%. The naive 10.38 ÷ 12 = 0.865% would have added about ₹80,000 to a ₹30.6 lakh answer, all of it invented.
The behavioural claim usually made for these plans is that they buy more units when prices are low, which is arithmetically true and much less powerful than the marketing suggests. It has two advantages. You make the decision once, and a plan running through a fall keeps buying when a discretionary investor would have stopped. Both are real. Neither is a return.
Advertisement
What is an STP and how is it taxed?
A systematic transfer plan moves a fixed amount at intervals from one scheme to another, typically from a liquid fund into an equity fund, and it carries a tax consequence that catches almost everybody. Each transfer is a redemption from the source scheme, and therefore a taxable event, and therefore a line the holder must report. Move ₹5,00,000 out of a liquid fund yielding 6.6% in ten monthly instalments of ₹50,000, with the balance compounding at the effective monthly rate between transfers. You realise ₹14,378 of gain across ten separate redemptions. The gain is taxed at the slab rate, because a debt-oriented scheme has no favourable long-term rate available to it [verify: the deemed-short-term treatment of specified mutual funds introduced by the Finance Act 2023 and refined by the Finance Act 2024, incometaxindia.gov.in]. At 30% plus cess that is ₹4,486 of tax and ten rows in a return. The liquid fund's 6.6% headline is really 4.5408% after tax to a top-slab holder, and the transfer plan generates the paperwork whether or not it generates the return.
Why is an SWP riskier than a SIP?
A systematic withdrawal plan redeems a fixed rupee amount at intervals and pays it out. It is the decumulation mirror of the investment plan and it is far more dangerous, for a reason the arithmetic makes unarguable.
A fixed rupee withdrawal from a falling portfolio redeems more units. Those units are gone. When the market recovers, it recovers on a smaller unit count, and the recovery cannot undo the redemptions. This is sequence-of-returns risk, and it means that two investors with identical average returns can end with radically different outcomes purely because of the order in which those returns arrived.
Worked example 4 runs the numbers in full. In short, a ₹1 crore corpus with a ₹60,000 monthly withdrawal, put through ten annual returns averaging 6.0%, ends at ₹48.05 lakh if the two bad years come first and ₹92.04 lakh if they come last. Same ten numbers, same mean, opposite order, and the bad-first investor ends with 52.2% of what the bad-last investor has. With no withdrawals at all, both orders end at ₹1,69,05,914, because multiplication commutes when nothing is taken out. Withdrawals are what break the commutativity.
How is an SWP taxed?
The tax side of a withdrawal plan is worth one line because it surprises people in a pleasant direction. Each redemption is matched against units on a first-in, first-out basis, so in a falling first year the redemptions realise losses. In the bad-first sequence, the twelve first-year redemptions consumed 8,030.16 units bought at ₹100 and returned ₹7,20,000 of cash, an ₹83,016 short-term capital loss. That loss is useful, it can be set off, and it can be carried forward. The same first year in the bad-last sequence produced a ₹35,971 short-term gain. Your tax is set by the order of the market's returns, and the withdrawal plan has no say in it.