Do you know that Systematic Transfer Plan (STP) is as powerful tool as Systematic Invest Plan (SIP)…
Yes it is true.
SIP has become a synonym with mutual fund investing. Majority people buy mutual fund units through SIP route only.
These days, it is not necessary to explain the meaning and purpose of SIP to common public.
But the concept of Systematic Transfer Plan (STP) is not as common among masses.
Though STP has been in existence for quite some time now, but it is not as popular as SIP.
The reason being, Systematic Transfer Plan (STP) finds its utility more with those investors who has lump-sum money for investing in mutual funds.
There are less ‘lump-sum’ investors around as compared to ‘small multiple payment’ investors.
But every time people cannot follow the SIP route to invest in mutual funds. SIP is useful when one has to invest gradually.
What strategy to be followed if one has comparatively larger amount available for investing?
The best answer is Systematic Transfer Plan (STP).
Why SIP has become so popular is because it enables people to automate their investment. Every month people need not think about how much to invest and where to invest. SIP does it for them automatically.
But even for these people who has become an expert of SIP, lump-sum investing looks like a foreign soil.
When a large sum of money comes in their hand in form of ex-gratia, bonus, allowance etc, they do not know how to deal with this extra cash flow.
They fear investing such a large sum of money in one go. There is a fear of making a mistake. More predominantly, their mind is not tuned to invest a lump sum amount.
As a result, that lump-sum amount stays idle in their bank account. Eventually the money gets spend on needless things.
Idle money is more prone to getting spent due to temptations.
Essential is to lock ones money before the temptations starts to kick in.
What is the solution?
The best solution is the use of Systematic Transfer Plan (STP).
What if I tell you a method using which you can invest your lump-sum money earned within the first hour the money gets credited into your account?
Yes this is possible.
Lets understand a small basic first.
#Equity linked investing is risky as in short term the price of equity options remain volatile. Hence we use the SIP method to speed our investment. This helps us to take advantage of the rupee cost averaging.
#Debt linked investing is considered safe. The returns are very predictable when we invest our money in debt linked plans.
What is suggested by experts is, if one has no clue of where to invest money presently, in this case invest your money in debt linked mutual funds.
As there is no risk of erosion of the principal amount in debt linked plan, investing like this is safe.
Once all the amount is invested in any debt linked plan, from here onwards, we can gradually transfer money from the invested “debt linked plan” to a new “equity linked plan” of our choice.
The only limitation is, the transfer can be within the same fund house.
Means, if you have invested in a debt linked mutual fund of Axis Bank, you can opt for systematic transfer plan (STP) within the mutual funds offer by Axis Bank only.
Though it is a limitation, but it still works fantastically.
Understanding Systematic Transfer Plan (STP)
What we do in SIP?
We have a lump-sum money parked in our savings/salary account. From this bank account, every month, a fixed amount gets debited, and this money is used to buy mutual fund units every month.
STP is also a form of SIP.
In fact STP is a combination of SWP and SIP.
In case of STP, the procedure is almost same. The only difference is, instead of bank account, here the account which is debited is the “debt linked mutual fund” where you lump-sum amount is parked.
In STP, funds from holding mutual fund is systematically withdrawn (redeemed). This withdrawn fund is then systematically invested (SIP) into other mutual fund.
The process looks like this:
Handling lump-sum amounts using STP
As soon as the lump-sum amount gets credited into your bank account, go to moneycontrol or valuereserachonline and pick a good debt linked mutual fund.
That’s all. Once the picking is done, you are ready to do STP.
#First step is to buy units of your preferred debt linked plan.
#Second step is to keep the invested fund stay locked for next one year. This will help to avoid the exit load.
#Third step is to start a STP (transfer) from debt linked plan to equity linked plan.
The transfer from debt to equity can be spread for a period as long as 2-3 years. In fact, the longer is the spread the better.
If you have subscribed to tools like fundsindia.com, they make the whole implementation of STP very easy.
Using fundsindia.com one can trigger systematic transfer of existing holdings to the other mutual funds (but within the same fund house).
This systematic transfer of funds from one mutual fund to other mutual fund is called systematic transfer plan (STP).
Advantage of following a STP route for investing?
Why one opts for STP instead of traditional investing?
Systematic Transfer Plan (STP) helps lump-sum investor to spread their invested money over a longer period of time (like SIP).
The idea behind spreading the fund is to prevent catching the equity market when it is too hot (at its peak).
The concept is to buy more fund-units when market is undervalued, and buy less fund-units when market is overvalued.
What is the result? One earns higher returns by avoiding market peaks.
But there are more advantages of STP than only earning higher returns. What are they?
This realisation that, there is a great option to invest ones lump-sum money without bothering, triggers the culture of investment.
This way people can prevent oneself from spending needlessly.
Even if one does not start a STP option here, the person will still earn higher returns (7% in debt fund) then a normal bank account (3.5% per annum).
If STP is initiated, the reaa advantage of it will be seen only after lapse of 3-5 years from start.
Example to understand the advantage of STP:
Suppose you got a bonus of Rs.100,000 on December 2007 (Sensex @ 20,800 levels).
As the stock market is doing great, you decided to invest your bonus in index linked mutual fund.
But considering that the Sensex is trading at all time high’s, you will have a doubt in your mind that whether it will be good to wait for the correction.
So here there will be two conditions:
#Condition 1: Investing in Lump-Sum without thinking much
You bought units of index fund.
But within next 3 months (march 2008), the stock market collapsed (Sensex @ 15,700 levels).
What does it mean?
The invested Rs.100,000 will reduce in value to Rs.75,000.
Suppose you held your nerves and decided to stay invested.
In next 12 month (January 2009), the stock market slumped further (Sensex @ 8,900 levels).
The invested Rs.100,000 will reduce in value to Rs.43,000.
A common man’s heart will sink after seeing such continuous sinking of funds value.
As a consequence, you will redeem even if you are at loss. On top of this, you will also take a pledge that you will never invest in equity again.
#Condition 2: Investing in Lump-Sum considering possible correction.
You bought units of a debt linked mutual fund.
Anticipating that the stock market may see correction within any time soon, you opted for STP. Rs.5,000 per month to be transferred from your debt linked mutual fund to an index linked mutual fund.
This style of investing talks about two important things.
One: You are aware of the conditions of the market. If Sensex is trading at all time highs, it a precondition that fall is only around the corner.
Two: You are also aware that buying equity when market is falling (undervalued), will give you higher returns.
Systematic Transfer Plan (STP) on paper may not look as advantageous. But if one decide to practice investing using STP as a tool, it will eventually help one to realize more about the market itself.
Having a deeper know-how about the market will in turn help to manage risks better and earn higher returns.
For me, Systematic Transfer Plan (STP) is one investment strategy that makes even a common man act like a wise investor.
Limitations of STP
STP is useful only for those people who have lump-sum money for investing.
Systematic Transfer Plan (STP) is effective for those people who desire to invest in equity by taking minimum possible risks.
These are some limitations of STP which is very evident.
But there is one big limitation of STP which is not as visible, but must be known to all investors.
What is it?
From January 2012 to March 2015 (3 years), the Sensex only rose higher and higher.
In such a condition (which happens rarely), Systematic Transfer Plan (STP) will not prove as beneficial.
In such condition, one time lump-sum investment will fetch higher returns (Buy low and Sell High).
Another limitation related to Systematic Transfer Plan (STP) is related to taxation.
When a debt linked mutual fund is redeemed, the profit portion will be taxable (capital gain tax).
Systematic Transfer from debt to equity mutual fund is treaded as redemption. And as the redemption is from a debt linked fund, income tax cannot be avoided.
If redemption is made within 12 months of purchase, short term capital gain tax will be applicable.
If redemption is made after 12 months of purchase, long term capital gain tax will be applicable.
But tax liability is one compromise which should be acceptable.
After-tax returns from debt fund is any how greater than interest earned on bank account. Secondly we are paying small-tax today, to earn a potential high future returns from equity.
The return from equity linked investing will be so high that the meager tax liability will not count much.
The only criteria in STP is to anticipate a possible stock market correction, and hold equity linked mutual fund units for at least 5-7 years.
This way Systematic Transfer Plan (STP) will prove very beneficial for lump-sum investors.
STP always keeps your money invested.
Have a happy investing.