Insights

FundsIndia Explains: What is an STP?

November 13, 2017 . Mutual Fund Research Desk

As the market touches new heights every week, people are rushing to put their money into mutual funds. It is important to sound a note of caution here. If you have a fixed deposit maturing or you have a large sum to invest, and you want to put this money into equity mutual funds, keep in mind that putting money in equities in one go is not safe. This holds true not just in today’s market but at any time you want to invest a bigger sum in equity funds. This is where a systematic transfer plan, or an STP helps.

What is a Systematic Transfer Plan?

Chances are, you would have heard of SIPs. SIP, or Systematic Investment Plan , allows you to invest money into mutual funds on a regular basis.

An STP allows you to transfer money from one fund to another in small chunks, on a regular basis. Just as an SIP is a standing instruction of sorts to debit your bank and buy units, an STP is also a one-time instruction which will redeem units from one fund at regular intervals and invest the proceeds in another fund with a matching regularity.

The STP will run for as long as you have units left in the source fund. You can set up an STP for different frequencies, depending on the platform you use for investing. On the FundsIndia platform, STPs can be set up with monthly, weekly or even daily frequencies.

Why and when to use an STP

At the time of investment into or redemption from equity funds, you always face the problem of timing. Are you investing at highs? Are you redeeming at lows just when you need the money? STPs help here.

Scenario 1 – You have a large sum of money to invest

If you come into a large sum of money, for instance, maturity proceeds of an FD, you might want to put it in equity funds. However, it is not a wise choice to invest large sums of money in equity at one go. You may invest when markets are at a high. It’s also hard to predict where the market might go. What if it corrects a couple of months after you invest? In volatile markets especially, you lose the chance of investing on sudden short-lived corrections if you put all your money in at one shot. The timing problem is why SIPs in equity are always recommended. However, if you simply start an SIP from your bank account, the money lying in your account will earn very low returns of 3.5-4%. To get around this situation, you use STPs.

To begin with, select an equity fund where you want to invest your money. Then select a liquid fund from the same fund house and put your entire money in this fund at one go. Now start a systematic transfer plan from this liquid fund to your equity fund at the frequency you desire. Your money will get transferred from the liquid fund to the chosen equity fund on a regular basis.

The advantages of this method are:

  • You do not take timing risk as your investments are spread over multiple months

  • You earn higher returns on your money as liquid funds usually deliver returns higher than savings bank account

Scenario 2 – You have equity investments and are nearing your goal

STPs can also be used to gradually bring down your risk as you approach your goal.

Suppose you have been investing in equity MFs for a few years and are now approaching your goal. You are fairly close to reaching your goal amount and want to start booking profits. But you are also afraid of losing out on future gains. Even worse, what if stock markets correct just in the year you want to withdraw from your equity funds? To get around this, you can set up an STP from your equity funds to debt funds. So now, you choose a low-risk debt fund. Then you set up an STP to redeem your equity fund at regular intervals and invest the proceeds in the debt fund.

By setting up an STP like this:

  • You do not lose out on future gains if the market continues moving up

  • If the market falls at any point before your goal is reached, you would have already booked profits and you are far less vulnerable to market shocks

  • The money you redeem doesn’t sit idle in your bank account earning low returns, as debt funds deliver better returns

Important points related to STPs

  • Source fund: Under the first scenario, you need to ensure that the source fund from which you are redeeming is a low-risk fund. The idea of an STP is to move gradually into a high risk fund. If your source fund is also high risk, the STP benefit is lost – a short-term NAV fall in the source fund will mean that you may be booking a loss at the time of redemption, inadvertently investing a lower amount. For this reason, a liquid fund is the best as they do not deliver losses even on a daily basis (barring very extreme circumstances).

  • Taxation of STP:  STP is treated the same as redeeming from one fund and investing into another. You have to pay tax on the capital gains earned from the fund you switch out of. For the fund you are switching into, the date on which the switch is executed will be treated as the date of Systematic Investment Plan investment for taxation.

  • Exit load: Exit load will be applicable because you will be redeeming from the source fund. However, liquid funds do not suffer exit loads. Some ultra short-term funds do have exit loads.

  • Only for sizeable amounts: This holds only for the first scenario discussed. Capital gains taxes have the potential of reducing your returns and the advantage over savings bank account is not much. For small amounts, you can start an SIP from your bank account itself.

  • Same fund house: STP can be set up between funds from the same fund house only. Keep this in mind while selecting your funds.

Get FundsIndia’s articles delivered straight to your inbox!

Enter your email address to get:

  • Mutual fund recommendations from experts
  • Buy, hold or sell calls for stocks
  • Investment tips and tricks
  • All the latest news from Fundsindia.com

Subscribe to Blog via Email

Enter your email address to subscribe to this blog and receive notifications of new posts by email.

Subscribe to Blog via Email

Enter your email address to subscribe to this blog and receive notifications of new posts by email.