Understanding STP in Mutual Funds: A Wise Investment Strategy To Reduce Risk

STP in Mutual Funds: A systematic transfer plan is an essential tool for irregular income earners or lump sum investors. Read on to know how and why it is done
STP in Mutual Funds
STP in Mutual Funds

STP in Mutual Funds: For individuals with irregular incomes, a systematic investment plan (SIP) is not plausible. However, lump sum investments would also expose you to market-timing risks and missed opportunities.

So, if you also find yourself in this category, your go-to investment strategy should be systematic transfer plans (STPs). Here, you would invest a lump sum in one fund and then periodically transfer a predefined amount, say monthly, to another fund.

Psychological Reassurance With STP

According to Ajay Pruthi, a Securities and Exchange Board of India (Sebi) registered investment advisor and founder of PLNR, STPs offer psychological reassurance to mutual fund investors.

“However, they don’t assure superior returns compared to lump sum investments. The outcome depends on the future sequence of returns,” he says.

Actually, investing a lump sum and employing a staggered approach would be of little significance in the long run. For instance, one may invest a lump sum of Rs 30 lakh into an arbitrage fund from which he/she can set up an STP into an equity index fund spread over 12-18 months. After 10 years, it would be of little significance whether the person invested his money in lump sum or in a staggered manner. However, adopting a staggered strategy can be instrumental in managing the emotional aspect of investments.

How To Implement STP?

One way to do this is to activate the STP feature on your liquid fund or any other fund with less volatility, such as in an arbitrage fund, and select another fund as a target within the hsame fund house. Your money will be automatically transferred to another mutual fund within the same fund house whenever you have an investable amount.

Benefits Of STP

Here are some of the benefits of STP.

Better Returns: STPs will allow your money to generate returns in the source scheme, such as an arbitrage fund or debt fund, before transferring it to an equity fund. Debt funds or arbitrage funds typically give higher returns than a savings bank account. Even liquid funds provide better returns than a savings bank account. The current category average of liquid funds is 6.93 per cent in one year. So, as long as your money remains in this fund before it is transferred to a target scheme, it can give you better returns than what you will get in a savings bank account.

Better Value for Money: STPs have the option to spread out your investment cost by purchasing fewer units at a higher net asset value (NAV), and more units at a lower NAV, thus ensuring a more balanced investment approach. Since the amount invested varies each month, it lets you buy more units when markets are down, and less when they are high. This can be achieved through a feature called flex or flexible STPs, which many fund houses now offer.

Reducing Risk: STPs are a valuable tool to shift your corpus from riskier assets to safer ones, thus making it an ideal strategy as you approach your retirement. Typically, the transfer happens from a low-risk fund, such as debt fund, to a high risk fund, such as an equity fund. Here, STP also removes the need of repeated investments and redemptions.

Says Pruthi: “However, STPs introduce unnecessary tax complexities as they require the accounting of capital gains from the debt fund.”

In conclusion, STPs provide a strategic approach for lump sum investments while mitigating risk and managing emotions.

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