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Using Systematic Transfer Plans (STPs) smartly

05 Jan 2023

A systematic investment plan (SIP) is quite well known and understood. Under an SIP, you invest a fixed sum of money into an equity funds each month. The key to an SIP is discipline and cash flow matching. By doing an SIP you match your investment outflows with your income. But above all, it is the discipline that matters. When you invest a fixed sum each month irrespective of the market levels, then over a period of time you stand to benefit. That is because you get the benefit of rupee cost averaging which tends to bring your cost of holding the fund lower.
But what if instead of getting regular income, you have got a lump-sum from the sale of a property and want to invest the same in equities. However, you are not sure if this is the right time to invest in equities or whether you should wait for better levels. While there are no clear answers to such questions, one of the methods is looking at a systematic transfer plan (STP). So, what exactly is a Systematic Transfer Plan (STP)? More importantly, how does STP work?
What is Systematic Transfer Plan?
Let us go back to the case of an investor who earns a lump-sum through the sale of property.  What he can do is to invest the entire money in a low-risk debt fund or money market fund and then systematically transfer a fixed sum of money into an equity fund. This will ensure that he gets the benefit of rupee cost average averaging and the money earns slightly more than his bank interest via a debt fund or money market investment. By regularly transferring money into an equity fund, the investor does not have to worry about the level of the market. For example, if he has a lump-sum of Rs.100,000 which he has invested in a debt fund, he can arrange to transfer a sum of Rs.10,000 each month into an equity-fund so that over the next 10 months he makes the best of the volatility in the equity markets and manages to reduce his cost of acquisition.
How does a systematic transfer plan work?
An STP is all about hitting two birds with one stone. On the one hand the phased approach to equities will enable you to reduce your average cost of holdings. The investment of Rs.100,000 will be spread across 10 months. On the other hand you put your idle money to better use. Consider the benefits in the table below

SIP Each MonthBalance in Debt FundYield on Debt Fund (9%)10,00090,00067510,00080,00060010,00070,00052510,00060,00045010,00050,00037510,00040,00030010,00030,00022510,00020,00015010,00010,0007510,000
Rs. 3375/-

As is evident in the above example, by doing an STP from the debt fund to the equity fund, the investor is able to invest an additional Rs.3375 that he earned from the debt fund also into his equity mutual fund SIP. The STP therefore provides the investor the best of both worlds; a higher return on the idle funds compared to a normal bank deposit and the benefit of rupee-cost averaging on his equity mutual fund investment.
What to watch out for while doing an STP
Before doing an STP, an investor needs to be clear about the tax implications of an SIP. When you take money out of the debt fund and invest in an equity fund, there is a capital gains implication on the debt fund portion. You need to be aware of how to address this issue. Consider the following points

Any transfer out of a money market mutual fund is not subject to exit loads. However, some may prefer an Ultra Short Term Fund or a Liquid Fund for the sake of higher returns. Most Ultra Short Term Funds and Liquid funds impose exit lot and that will change the economics of your STP.

While opting for a debt fund to park your money, select a dividend plan so that there are no capital gains tax implications on your debt fund when you move out of your debt fund and into your equity fund.

You must always keep a Nifty valuation benchmark in mind while getting into an STP. STP from a debt fund to an equity fund may not make sense when the Nifty is quoting at above 25 times P/E. Similarly, the reverse STP will not make sense if the Nifty P/E is less than 12 times.

Like in case of an SIP, discipline lies at the core of an STP. If you disrupt the STP in between, then the advantages of an STP strategy will largely get frittered away. You need to continue the STP for the number of periods that you originally envisaged.

Understanding what is an STP and how an STP works is at the core of making a success of the STP. The trick lies in using STP smartly!

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