What is Mutual Fund systematic transfer plan and how it defends volatility
Mutual funds offer a variety of smart and convenient solutions to address specific investment needs of the investors. Systematic Transfer Plan or STP is one such solution. Using STP, investors can transfer a fixed amount from one scheme to another at a regular frequency. A variant of STP, known as Systematic Switch Plan, is also offered where investors can transfer a certain number of units from one scheme to another. STP is primarily used by investors to transfer from debt funds to equity funds and vice versa.
There are two types of Systematic Transfer Plan (STPs) -
- Fixed STP Plan – Investors can transfer a fixed amount at regular intervals from one scheme to another. A popular way of STP is to park a lump sum in liquid funds and transfer a fixed amount either daily or weekly or fortnightly or monthly to equity funds.
Please check how a fixed STP works in case of transfer from liquid to equity funds
- Capital Appreciation STP in which investors can take out the profit of a scheme and transfer it to another scheme. For example – you can transfer the profit of your equity fund to liquid funds.
Please check how a profit transfer STP works in case of transfer from balanced funds to liquid funds
STP is a good defence against Volatility
Systematic Transfer Plan is a very effective and convenient solution in providing protection of investor’s money in volatile markets. For example if an investor wants to invest in an equity fund but is worried that the market may fall in future, he / she can invest in a low risk funds like liquid or ultra-short term funds and transfer money at regular intervals (daily, weekly, fortnightly, monthly etc.) to the equity fund. STP will ensure rupee cost averaging of purchase price along with returns on the liquid / ultra-short term funds.
Let us understand this with an example –
Ramesh wants to invest Rs 1 lakh in an equity fund, but he is worried that the market may remain choppy in the next one year. He can invest the money in a liquid/ ultra-short term fund and use STP to transfer a fixed amount to the equity mutual fund every month. Let us assume that the liquid/ ultra-short term fund gives an annualized return of 7%.
The table below shows how the STP will work over the next 12 months (NAVs are purely illustrative).
You can see in the table above that the NAV at the time of investment was Rs 100 and the NAV at the end of the year was Rs 110. If Ramesh had invested his money in the equity fund in lump sum, he would have purchased 1,000 units and the value of his investment at the end of the year would have been Rs 110,000.
However, using the STP routeRamesh was able to purchase additional 40 units (total 1,040 units) and the value of his equity investment was Rs 114,414 at the end of the year. Further he also had a balance of Rs 3,355 in the liquid fund. Therefore, his total investment value, at the end of the year was Rs 117,769. Using the STP route, Ramesh was able to make an additional profit of Rs 7,769 through rupee cost averaging of the unit prices and also through the extra returns earned on the liquid fund.
Typically STPs are used to transfer from liquid funds to equity or balanced funds. However, investors can use STPs to transfer between other schemes depending on their asset allocation or investment needs. For example, investors nearing retirement can use STPs to shift their equity mutual fund investments to long term income funds or monthly income plans (MIPs) to reduce the risk and also to earn a regular return on their investments.
Investors should note that STP is possible only when both the schemes - the transferor scheme (scheme from which you are transferring) and the transferee scheme (scheme to which you are transferring) - belong to the same mutual fund house (AMC).
A word of caution if you are doing a STP – Like any other way of investing in mutual funds, STP also needs financial discipline. You should not stop your STP because of very short term market movements as it may end up harming your long term investment returns. For example, if you have started a 6 months STP from liquid funds to equity funds, you should not stop your STP if the markets suddenly rises or corrects sharply. Stopping the STP based on market movements means trying to time the market which always is a very difficult and almost an impossible task.
STP precludes the necessity of timing the market and helps you optimize the return on your investment by taking advantage of volatility and being disciplined.