You have just sold a piece of land in your ancestral village to a large corporate for setting up a factory and have been paid Rs.10 lakhs for the same. That is a sizable sum and your primary focus will be to make the best use of it. Since, you have received a lump-sum of Rs.10 lakhs; you may want to use a small part of the amount to pay off your loan and the balance to be invested for long term growth. But you have a problem! You are aware that a Systematic Investment Plan (SIP) works best due to rupee cost averaging. But since you have received a lump-sum, you cannot do an SIP.
That is where most investors get it wrong. Even a lump-sum amount can be converted into an SIP through a process called Systematic Transfer Plan (STP). What you do in an STP is that the entire corpus is invested into a debt fund or a liquid fund and each month a fixed sum can be swept into an equity fund. As far as your equity fund is concerned, you are still doing an SIP and getting the benefit of rupee cost averaging. At the same time, the idle money earns a higher yield in a liquid fund compared to your savings account. Let us assume that out of his funds received, he allocates Rs.500,000 and sweeps Rs.25,000 each month. How will the impact be?
How the STP actually works in practice..
MonthBalance in Liquid FundReturn at 0.5% p.m.
Equity Fund SIP CorpusFund Returns 1.25% pmJan 2017475,0002,375
65,630 (Z)Value at the end of 20 months = X + Y + Z
Had you done a pure SIP in the above case, your corpus would have been worth Rs.5,71,000 at the end of 20 months. In the above case, the STP gives you the benefit of an SIP as well as the idle corpus being fruitfully utilized in a liquid fund instead of in a savings bank account.
Why STP will work more effectively than a lump-sum investment..
In the above case we have assumed that the NAV of the fund appreciates by 15% annually and that is spread equally at the rate of 1.25% per month. In reality, you never get such situations because the monthly returns could be highly erratic. That is where the importance of an STP becomes more pronounced. Here are 5 reasons an STP can really add value for you..
It is never possible to time the tops and the bottoms of the market. An STP solves the problem by adopting a rule-based approach. When the NAV goes up you are anyways gaining on your corpus and when the NAV goes down you are getting more units.
Over a longer period of time, like in the case of SIPs, the STP will also ensure that the average cost of your holdings come down and that will enhance your returns.
STPs benefit you in two ways. Firstly, the liquid fund helps you earn a higher return on idle funds while the STP into equities gives you the advantage of rupee cost averaging. This dual benefit is likely to be more visible when you are in volatile markets.
A lump-sum investment becomes a one-time commitment and if the price goes down subsequently then you are stuck with MTM losses on a position you cannot liquidate. The calibrated approach of an STP solves that problem.
The famous active bias is avoided in an STP. When it comes to lump-sum investing, your returns will depend on the level of the Nifty, the price of entry, choice of fund etc. In an STP, you can also change your fund choice if you are not happy with the performance.
Don’t forget the tax implication of STP..
A very important consideration for you will be the tax implication of an STP. Remember, when you invest in a liquid fund and sweep funds into an equity fund, then each sweep will be treated as redemption of the liquid fund. Since liquid funds are non-equity funds they will be classified as STCG up to 3 years and will be taxed at your peak rate of tax. Even beyond 3 years, gains are still taxed at the rate of 20% after considering indexation. This will impact your net returns. Also, liquid funds do not charge exit loads but Liquid-Plus funds and other debt funds have an exit load and that also needs to be factored into calculations.
Even if you have lump-sum funds, the STP offers you a good way of converting it into a quasi-SIP. In volatile markets, that is the right choice!