How to effectively use Mutual Fund STPs to enhance returns - Motilal Oswal
How to effectively use Mutual Fund STPs to enhance returns - Motilal Oswal

How to effectively use mutual fund STPs to enhance returns

We all are quite familiar with the advantages of a systematic investment plan (SIP). After all, SIP gives you the advantage of rupee cost averaging which reduces your cost of holding mutual funds over a period of time. Additionally, the SIP also synchronizes your inflows with your outflows and inculcates savings and investment as a regular habit. Lastly, SIPs bring the power of compounding to your portfolio wherein you are able to create wealth over the long term.

 

The SIP idea is a great but what if you get a lump-sum. Let us say, you had resigned your last job and you just got a cash infusion of Rs.2,00,000 as your gratuity share. That is big lump-sum and you are wondering what to do. You are not sure if this is the right time to invest in equity mutual funds or whether you should wait for lower levels to buy. The answer to all your questions could be a systematic transfer plan (STP). An STP is the structured equivalent of an SIP when you get money in lump-sum. Let us understand the benefits of STP in mutual fund and how to use STP in mutual funds. Let us also look at the best structures and the STP investment ideas with the best STP plans.

 

How exactly does a STP work?

Let us briefly engage in the methodology of how an STP functions. When you get a lump-sum as in the above case, it is never easy to time the market and buy at the bottom of the market. A better way will be to put the entire money in a liquid fund and then sweep a fixed sum of money out of your corpus as a STP into an equity fund. This liquid fund earns higher than letting the money idle in a bank deposit while the STP works exactly like a SIP and gives you the advantage of rupee cost averaging. Remember, to opt for a growth plan of a liquid fund and then structure these withdrawals as an SWP to minimize your tax impact. Also, make it a point to ensure that you are invested in liquid funds with zero exit loads. While proper liquid funds are free of exit loads, there are near liquid fund and ultra short term funds which attract exit loads.

 

The advantage of using an STP on MF over lump-sum investing
The above table captures how an STP can be structured for maximum benefits in terms of return and risk. The investor has received a corpus of Rs.2 lakhs as gratuity. The entire corpus is invested in liquid funds with zero exit loads and yielding 6% return per annum on an average. On a monthly basis, the investor allocates Rs.14,800 to an equity fund which is an STP done from the liquid fund. Over the next 14 months, the regular STP works like an SIP and gives the investor the benefit of rupee cost averaging. At the same time, the idle funds earn a higher return on the liquid funds as compared to a savings bank account. Let us look at the outcome in the form of a table..

 

Lump-sum InvestedAmountsSTP StructuredAmountsTotal  CorpusRs.2,00,000Total CorpusRs.2,00,000Units allocated at
12.35 NAV16,194.3320 unitsUnits allocated via STP -  Systematic Transfer Plan17,510.9536 unitsFinal Value at 12.95 NAVRs.2,09,717Final Value at 12.95 NAVRs.2,26,767Returns (%)4.86%Returns (%)13.38%

 

As you can see from the above table, the STP has distinctly outperformed the lump-sum investment by a big margin. Instead of putting the money in lump-sum or worrying about the market tops and bottoms; the investor would have been better off if an STP had been structured to invest the money in a liquid fund and then structure an STP that regularly transfers a fixed sum into an equity fund.

 

Why has the STP into equity fund performed better?

The STP has outperformed the lump-sum investment in mutual fund for 3 clear reasons:

 

1.  Since the markets have been volatile in the last 14 months, the STP investor has got the best of the ups and downs in the market due to the power of regular investing.

2.  The concept of lump-sum investing is based on the belief that it is possible to identify market tops and bottoms and capitalize accordingly. But, that is not practical!

3.  Lastly, the liquid fund has given 6% annualized returns and that has made a better use of the idle funds; thus enhancing your overall returns. That is how and STP works better!
 

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