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All you wanted to know about STPs

It is often done by investors to mitigate the risk to capital especially while investing in equities. The most common way to do STP is by doing transfers from a debt fund to an equity fund.

Avaneesh recently sold some assets and got a lumpsum amount. Often, such lump-sum amounts idle away in his bank account because of tax refunds, bonuses or sale of assets. 

Is there a better way out for him?

Many experts suggest the Systematic Transfer Plan or STP in short. 

What is an STP?

It is an automated process of transferring money from one mutual fund to another over a period of time. It is often done by investors to mitigate the risk to capital especially while investing in equities. The most common way to do STP is by doing transfers from a debt fund to an equity fund.

How does it work?

If you have Rs 20 lakh that will not be needed for the next ten years, you can invest it initially in a reliable debt fund and opt for a fixed STP towards equity funds for the next two years. In this case, the lump sum amount is converted into 24 fixed STP instalments of Rs 83,000 per month. STP transactions are executed on the same day by redeeming one fund and by purchasing another. 

By staggering investments over a period of time, STP works towards investing across the market cycle and thereby reduces market risk. By automating the process, you also do not have to repeatedly resort to redemption and investment in various funds.

Types

STP can be of three types; Fixed STP, Capital Appreciation STP and Flexi STP. 

In Fixed STP, the investor chooses to transfer a fixed sum of money from one fund to another. This is the most popular type among all.

In Capital Appreciation STP, an investor takes out only the gains made in one fund and reinvests into the other.

In Flexi STP, the investor has a choice to transfer a variable amount depending upon the market conditions.

How is it different from SIP?

In case of a Systematic Investment Plan (SIP) money is transferred from your bank account, whereas in the case of STP it is done from one fund to another. Nevertheless, it needs to be noted that STP can happen only between funds of the same fund house (AMC).

Why is it better?

By staggering investments over a period of time, STP works towards investing across the market cycle and thereby reduces market risk. By automating the process, you also do not have to repeatedly resort to redemption and investment in various funds.

Furthermore, while you invest systematically into equities – the STP way, the rest of the money - instead of idling away in a bank account - earns you more by being deployed in safe debt funds. 

Fund over bank a/c

Some categories of debt funds, especially the liquid and ultra-short debt funds are more secure and liquid. In the last three years, liquid funds have yielded about 6-7% annually as compared to 4% from a savings bank account. Furthermore, they have also provided better post-tax returns than that of bank fixed deposits across time horizons.

Time horizon

STP into equity funds works only if you have an investment horizon of at least 7-10 years. Equities while providing the best inflation-beating returns among all the asset classes are also volatile. So, you need to stay put for a long time to leverage its benefits. If you have a shorter investment horizon, invest it all in low duration debt funds.

Frequency and tenure

You can choose any frequency – daily, weekly, monthly or quarterly. The monthly is the most convenient.

The tenure of STP should be at least two to three years, especially if you are choosing to invest in equities. 

By choosing STP, you don’t eliminate the market risk but manage it better. 

Tax liabilities

Every transfer made from debt fund to equity fund is considered as redemption and new investment. And the redemption is taxable - the money transferred within the first three years from a debt fund is subject to Short-Term Capital Gains (STCG) at the marginal tax rate. 

Investment discipline

STP requires discipline while investing. If you stop your STP mid-way due to market fluctuations, then it will not serve the purpose. While investing in debt funds, ensure also there are no exit loads, while the destination funds fit into your overall financial plan. 

Takeaway

STP is a smart way to invest your lump sum money into equity funds. By staggering investments, it mitigates market risk.

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