Taking the SIP route does away with the risk to a large extent, especially in the long term. However, mutual fund investors have another option, which promises superior returns from equities with minimal risk-systematic transfer plans (STPs). Let's look at how theSTP structure works and whether it can add value to your investments.
What is an STP?
The STP route is an extension of the SIP way of investing. While SIPs allow you to invest small amounts of money in a mutual fund at regular intervals, STPs enable you to transfer money already invested in a mutual fund into another fund of your choice. Investors typically park a lump sum in a debt fund, say, an income fund, from which a fixed sum is transferred at periodic intervals into an equity-oriented fund. So, units equivalent to the transferred amount will be sold from the primary scheme and the same will be utilised to buy units in the new scheme. This switch to the new scheme is carried out at the prevailing net asset value (NAV). Some STPs also allow you to gradually shift investments from an equity fund to a debt fund. The best bit is that you can use the STP to transfer funds into several schemes at the same time.
There are two types of STP plans that are offered by fund houses-fixed and flexible. Under a fixed STP, a pre-defined amount is transferred from the primary fund to the other fund or funds each time. On the other hand, in case of a flexible STP, there is no predetermined value; the capital appreciation in the primary scheme is transferred to the other scheme(s).
STPs typically require the investor to make a specified minimum investment in the primary scheme (which is otherwise applicable under the normal investment plan). Some asset management companies (AMCs) also specify a minimum transfer amount that can be switched each time from the primary fund to the others, apart from a certain minimum number of instalments every year.
A few fund houses even specify the monthly dates on which investors can activate the STP. For instance, for a monthly STP from a debt scheme to an equity scheme, some AMCs require the investor to have an investment of at least Rs 12,000 in the primary scheme, which can be transferred through a minimum of six instalments in a year, with the minimum transfer amount of Rs 1,000.
Doing the math
To understand the transfer mechanism, let us consider an example. Suppose you invest Rs 60,000 in a particular debt scheme (Scheme A) and want to start switching Rs 5,000 from it to an equity fund (Scheme B) every month for a year. You activate an STP at the start of the year, and every month, Rs 5,000 starts flowing from Scheme A into Scheme B. The fund value of Scheme A starts falling to the extent of this outflow, adjusted for gains or losses it makes every month. Meanwhile, the investment value of Scheme B rises by Rs 5,000 every month, in addition to the gains or losses it makes.
As you can see in the graphic 'How an STP works', Rs 60,000 is invested in Scheme A at the beginning of the year, which helps buy 600 units. In the next month, some units are sold and the proceeds from these (Rs 5,000, the predetermined amount) is shifted to Scheme B. The balance amount left in Scheme A is higher at Rs 55,420 rather than Rs 55,000 because of the profits made on the investment due to the rise in the NAV. The benefit of the STP is that even if the NAV declines in one fund, it's possible that it will rise in the other scheme, thus ensuring that you do not suffer a loss.
By spreading your investments through instalments and across market conditions, the STP allows you to average out the purchase cost of your investments and gives you a better chance to earn high returns over a period of time. This especially works in your favour when the markets are either volatile or in a downtrend.
STPs also ensure the optimum use of idle money. Instead of idle cash lying in your bank account, any lump sum invested in a debt scheme will fetch higher returns. This means that your money is already growing at a decent rate before you take the STP route and switch a certain amount to a better-yielding equity fund. Says Hemant Rustagi, CEO, Wiseinvest Advisors: "STPs are ideal for those who have a lump sum to invest but don't want to commit all the money at one go. It will also fetch more tax-efficient returns since the amount invested in debt earns higher post-tax returns than the low yield offered by savings accounts."
Finally, STPs are a handy tool to ensure the realisation of one's financial goals since it gives you time to react to the market's mood swings. So, if you have been saving for your daughter's marriage by betting on equity funds, what happens if you see signs of the market tanking barely six months before the wedding? Playing the wait-and-watch game might result in a 50% drop in the value of your equity fund. To avoid such a situation, it will make sense to gradually move the money from equities to debt through an STP. Hence, STPs can also work as systematic withdrawal plans (SWP), where the money from an equity fund can be gradually withdrawn, but will flow into a debt fund and continue to grow instead of sitting in your bank account. As Srikanth Meenakshi, director, FundsIndia.com sums up, "STPs can be used to book profits in the equity fund in a phased manner and investing the same in a liquid fund. This could possibly fetch you a better selling price over time."
Shortcomings of an STP
Since the STP involves the sale of units from the primary scheme, every time you transfer your money into another scheme, you may have to bear an extra cost. If such units are sold within a year of investment, you may have to pay a capital gains tax-15% in the case of equity schemes, and as per the applicable tax slab for debt schemes. An exit load (usually 1%) is also applicable if you switch units from the primary scheme into another within a year of investment. In case of a switch from an equity fund, a securities transaction tax (STT) at 0.125% (0.1% from next year) will be deducted at the time of making the switch.
The fact that not all fund houses offer STPs from equity schemes to debt schemes means that one can put one's investment value at risk. As pointed out earlier, if one doesn't shift out of equities gradually when an important financial requirement is nearing, goals can be jeopardised. Says Rustagi: "A year before your goal is to be reached, you should start an STP into a debt fund, removing money from the equity fund in a staggered manner."
The biggest drawback of an STP is that your choice is limited to the schemes of the same fund house. This prevents you from effecting transfers into multiple schemes of your choice from different fund houses, picking the best of the lot.