Basics of Systematic Transfer Plan

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A systematic transfer plan (STP) is an investment strategy that allows investors to transfer a fixed amount of funds from one mutual fund scheme to another at regular intervals. This systematic approach helps investors to potentially benefit from market fluctuations and manage their risk exposure over time. STPs are particularly useful for investors who wish to gradually shift their investments from one asset class to another or maintain a disciplined approach to investing while reducing the impact of market volatility. Understanding the basics of STPs can empower investors to make informed decisions and optimise their investment portfolios effectively.

Understanding STP

  • Understanding STP begins with grasping the concept of systematic investment plans (SIPs), which offer investors a disciplined approach to investing by allowing them to invest a fixed amount regularly, typically monthly.
  • SIPs are valued for their ability to mitigate volatility in investments, providing investors with a consistent investment strategy.
  • In contrast, STP is a variation of SIP that enables investors to gradually transfer assets from one mutual fund scheme to another within the same asset management company.
  • When investors possess a lump sum amount for investment, registering for a SIP may not be feasible. In such cases, investors can opt for a lump sum investment in a mutual fund or ETF. However, this approach carries higher risk, particularly in equity and debt funds.
  • To mitigate risk, asset management companies offer STPs, allowing investors to systematically transfer a fixed sum from one fund to another, akin to a series of pre-scheduled switch transactions.

Defining STP

  • STP allows unit holders to transfer a fixed sum at regular intervals from one scheme to another, resembling a series of pre-scheduled switch transactions.
  • This facility aids investors in rebalancing their investment portfolio by seamlessly switching between different asset classes, helping to reduce volatility and achieve financial goals.
  • For instance, an investor with a lump sum from the sale of property can invest it in a low-risk money market or liquid fund, systematically transferring a fixed sum into an equity fund to earn higher returns than bank deposits.
  • By regularly transferring money into an equity fund, the investor can mitigate concerns about market levels and benefit from volatility over time.
  • For example, if an investor has ₹5 lakhs and invest in a liquid fund, they can transfer ₹25,000 monthly into an equity fund over 20 months, optimising volatility and reducing the cost of acquisition.
  • STPs are ideal for investors with lump sum amounts who wish to invest in equity funds but are hesitant to time the markets.

Types of STPs

  • Fixed STP: In this, investors take out a fixed sum from one investment fund and transfer it to another fund.
  • Capital Appreciation STP: In this, the investors take out the profit that they have made on one investment and invests in another investment fund.
  • Flexi STP: In this, investors can choose to transfer a variable amount. The fixed amount would be the minimum amount and the variable amount depends on the volatility of the market.

Starting an STP

  • Determine the amount to be systematically transferred from the source fund to the target fund based on one’s risk appetite and financial objectives.
  • Select the time frame within which one intends to execute the systematic transfer from the source fund to the target fund.
  • Set up an automatic transfer by specifying the source and target mutual funds.

While starting a STP, one must remember:

  • STP occurs between mutual funds within the same fund house (AMC).
  • It involves redemption in one fund and purchase in another.
  • Opt for source funds with low or no exit load and expense ratio.
  • Choose destination funds based on one’s investment goals and preferences.

Benefits of STP

  • Rupee Cost Averaging: STP averages out the cost of investment–more units at a lower price and fewer units at a higher net asset value (NAV). As the money transfers from one fund to another, the fund keeps purchasing additional units systematically, benefiting one from Rupee cost averaging, i.e., the per-unit cost will reduce gradually.
  • Managing Risks: These can also be used to move from a risky asset class to a less risky asset class. For example, suppose an investor initiates a SIP for 30 years into an equity fund for retirement purposes. As the investor approaches retirement, they can initiate an STP to safeguard against potential declines in the fund’s value. By instructing the fund house to systematically transfer a specified amount from the equity fund to a debt fund, they can mitigate risk and ensure a smoother transition into retirement.
  • Scope for Higher Returns: Opting for an STP can translate into higher returns because it allows one to initially invest the lump sum into a debt fund like a liquid fund. These liquid funds generally yield higher returns than leaving funds in savings or current accounts.
  • Optimal Balance: The best STPs aim to create a portfolio that has an optimal balance between the equity and debt instruments. It also aims to provide an optimal combination of risks and returns. For risk-averse investors, the transfer of funds is mainly to sovereign-backed debt securities, while equity instruments are meant for investors with a willingness to take some risk.
  • Conversion to Direct Funds: A systematic transfer plan can also be used for switching from regular mutual funds to direct mutual funds and thus avoid the higher expense ratios charged on regular mutual funds.

Disadvantages of STP

  • Exit Load: It is applicable when an investor switches from one scheme to the other, especially when the units of the source scheme are redeemed in a short time frame.
  • Taxation: Short term capital gain (STCG) tax is applicable on STP. This happens because units are essentially redeemed from one scheme and are invested in another scheme. The consideration of a switch as redemption prompts this capital gains tax.
  • Limited Fund Choice: The switch from one scheme to another is allowed only for schemes managed by the same fund house. Suppose one wants to switch the debt fund of X fund house, one can only transfer to an equity fund of the same fund house, i.e. X.

STP Vs SIP

STP functions similarly to a SIP, where a fixed amount is invested in a specific fund. However, if one has a lump sum to invest, it’s more beneficial to use STP. In SIP, the amount remains idle in one’s bank account or earns minimal interest, whereas, with STP, one can invest the lump sum in a low-risk debt fund and then gradually transfer it to equity funds, potentially earning higher returns.

Conclusion

STP offers investors a disciplined approach to gradually transfer funds from one scheme to another within the same fund house. By leveraging STP, investors can manage volatility, rebalance their investment portfolio, and potentially realise their financial goals more effectively. This strategy allows for a systematic shift between different asset classes and can be particularly useful for investors with lump sum amounts to invest or those approaching retirement.

Frequently Asked Questions (FAQs)