Mutual funds have become a popular way to build wealth. When investing in a mutual fund, investors employ a variety of strategies. The Systematic Transfer Plan, or STP, is one such strategy. While it is similar to the Systematic Investment Plan (SIP), there are some significant differences.
Plan for Systematic Transfer
A systematic Transfer Plan is a method of automating funds transfer from one mutual fund scheme to another. Investors typically prefer it with a lump sum saved but do not want to time the market.
Typically, investors in this strategy transfer funds from a debt scheme to an equity scheme.
How it works
Assume an investor has a ₹10 lakh savings account, but the markets are volatile, and he does not want to invest in an equity fund right now. As a result, the investor places the entire corpus in a debt fund, which is considered safer than equity funds and typically provides a reasonable rate of return.
He then configures STP for his preferred equity funds. Rather than deducting money from his bank account as in a SIP, the fund is transferred from his debt fund to his desired equity funds at regular intervals.
So, in this scenario, he not only earns the higher interest rate offered by the debt fund than the bank account, but he can also set the amount he wants to transfer regularly (monthly, weekly) to his preferred equity funds.
As a result, the equity funds receive a set amount deposited at regular intervals, similar to a SIP, but from a debt fund account rather than a bank account.
However, it should be noted that for this to work, you must select mutual fund schemes from the same fund house. The transfer can only be made between two or more schemes of the same fund house, not between multiple fund houses.
An investor can initiate an STP among two Reliance Mutual Fund’s mutual fund schemes but not among one Reliance Mutual Fund and the other Aditya Birla Sun Life’s mutual fund schemes.
Why should you buy an STP?
The main advantage of starting an STP is that it reduces market timing risk. Because equity markets can be extremely volatile, investing in a lump sum may not always be a good idea. Because of the power of compounding, investing regularly increases returns in the long run.
This is why regular payments, whether SIP or STP, are more common and effective than lump-sum payments for an equity mutual fund. If you have a large volume invested in an equity fund and the market collapses, the whole fund will be lost; however, with an STP, this risk is mitigated because only a portion of your funds has been invested in the equity fund, so the whole fund will not get impacted by such a loss.
Furthermore, investing a lump sum in a debt fund protects your entire corpus from market fluctuations. This way, the investor’s money generates good returns while regularly being invested in equity funds.
Who really should make a financial investment?
Only if one has a sizable savings account should one consider investing in an STP. If one receives regular payments, one can use the SIP method. Additionally, investors who tend to go for low to medium-risk investments should choose SP, while those with an appetite for high-risk investments should invest their lump sum in an equity fund. While the risks are higher, so is the potential return.
Quantity and frequency
After deciding which debt fund to invest your lump sum in, you can select your destination funds, the frequency with which you want the money transferred from your debt, and the amount for the transfers.
One’s destination equity fund portfolio should be balanced, diverse, and aligned with one’s financial goals and risk tolerance. If you are a low-risk investor, you can move your money from a debt fund to a safe large-cap fund or an index fund.
One can choose to smallcap or midcap funds if one wants a higher return rate and is willing to take risks. You can also select a mix of high-quality funds. Transfer a small portion of your portfolio to large-cap funds, a portion to small-cap funds, and a portion to sector funds to diversify your portfolio.
STP versus SIP
While STP and SIP involve regular investments in equity mutual funds, the money for SIP comes from your bank account, whereas the money for STP comes from your debt fund.
Also, because you are receiving returns from your debt fund, STPs provide higher returns than SIPs. Debt funds do not have the same robust rate of return as equity funds, but they generate decent returns of around 10% and are immune to market volatility. You get the benefit of debt fund returns with STP. In the case of SIP, the bank account offers almost no interest rate, so you do not benefit from that.
Third, SIPs are typically unrestricted. There is no set timetable for investment. You can invest for as long as possible and withdraw whenever you wish. This is not true of STPs. The amount and the period of transfers are fixed in this. You must specify the transfer duration, such as 6 months every month, after which the transfers to your target equity fund will cease.
The income tax for SIP and STP is also significantly different. When using STP, every transfer from a debt fund to an equity fund is treated as redemption in the debt fund, and you will be subject to short-term capital gains tax. In SIP, this is not the case.
SIP requires you to pay long-term capital gains tax and short-term capital gains tax, depending on how long you hold your funds.
STP is the best way to invest a lump sum in equity funds, especially in a volatile market. Not only do you get returns from the equity fund, but the debt fund also contributes significantly. On the other hand, SIP may be a better investment strategy for you if you do not have a large corpus.