We have all heard of the merits of a systematic investment plan (SIP) wherein you stagger your investments by investing a certain amount each month into a mutual fund (typically an equity fund). That fits in perfectly if you are looking to regularly invest a part of your monthly income into an equity fund for long term wealth creation. But what if you have received a lump-sum inflow of ₹7 lakh from the sale of your ancestral agricultural land? Investing the entire amount in one go is not advisable as you can never predict tops and bottoms in the market. The answer will be a Systematic Transfer Plan (STP).
So, what exactly is an STP?
In a systematic transfer plan (STP), the investor instructs the mutual fund to regularly redeem/switch units from one fund and invest in another fund of the same fund house. This STP can be done at a regularity of 1 month, 1 fortnight or even 1 week as is suitable to you. In the above case, the ₹7 lakhs that you received from the sale of your ancestral land can be entirely invested in a liquid fund or an ultra short-term fund. Then you can design an STP in such a way that each month a fixed sum of, say, ₹10,000/- automatically transferred from the liquid fund into an equity fund. This is how an STP operates. The advantage is that your entire corpus is parked in a liquid fund and hence your money is not sitting idle.
It is actually earning a rate of return that is higher than what you would be earning on your savings bank account with the benefit of 100% liquidity. There is an important aspect of exit load that you need to be aware of. When you switch out of one fund in a period of less than 1 year, there is an exit load that is imposed that will reduce your NAV realization. However, in the above case, since the switch out is from liquid funds you are safe as liquid funds normally do not attract exit loads.
How exactly do you benefit from a systematic transfer plan (STP)?
From an investor’s point of view, an STP confers three very important benefits.
- Firstly, there is the benefit of rupee cost averaging that is being made available to you through the STP. In the above case, instead of investing ₹7 lakhs in lump-sum you are breaking up the corpus into ₹10,000/- per month and creating a quasi-SIP. Your average cost is likely to be lower than your lump-sum cost in normal circumstances.
- Secondly, the STP can actually perform the role of a balanced fund. You are constantly tweaking your mix between debt and equity in a systematic manner. Thus your lump-sum is earning more than your savings bank account as it is invested in a liquid fund. At the same time, the transfer into an equity fund each month is also working towards your long term wealth creation.
- Thirdly, there is a constant rebalancing of your portfolio that is happening as you keep shifting between debt and equity. That also ensures that you are exiting debt in the most profitable manner possible and you are entering equity in the most profitable manner possible. This provides you a low-cost approach to rebalancing your portfolio.
What are the different ways in which to structure the STP?
While the STP may appear to be a plain vanilla method of transferring funds between debt and equity, there are more sophisticated methods of doing an STP. Broadly, there are 3 ways to structure your STP:
- The ultimate plain-vanilla approach is that of a fixed STP. The above example of converting your ₹7 lakh lump-sum into a fixed STP of ₹10,000 per month is an example of a fixed STP. Here the amount remains fixed through the tenure.
- The second category is a capital appreciation STP. In this case, only the capital appreciation is swiped out of the main fund and the principal remains intact. This may be a good method of taking profits out of equities or out of debt funds when interest rates have fallen sharply.
- The third conditional is what is called a conditional STP which is dependent on the level of the market and the Nifty P/E. For example, the instruction can be that if the Nifty P/E goes below 18X then increase the STP amount to ₹15,000/- per month and if it goes above 24X, then make it ₹5,000/- per month. Within the range you can instruct to maintain the STP at ₹10,000/- per month.
Let’s go for the cliché (last but not the least, things to remember about STPs)
The most important thing to remember in STP is the exit load. Some funds offer zero exit load STP, which will be a big saving for you in terms of costs. Try to make the best of such offer the big question is whether you must choose a growth scheme or dividend scheme in a liquid fund? Both of them have a cost attached. Growth schemes of liquid funds attract STCG of 30% if exited before 3 year if you opt for a dividend scheme, the fund deducts 28.84% dividend distribution tax (DDT) before paying you the dividend. These are costs you need to factor into your calculations!
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