With the markets volatile, investors may hesitate to invest lump sum in equities. Systematic transfer plans (STPs) provide an effective way to navigate volatility while ensuring market participation over time.
Instead of keeping money in a low-yield savings account, STPs allow investors to earn additional returns while waiting. It gradually transfers money from a low-risk liquid or ultra-short-term debt fund to an equity fund over six to 18 months, ensuring a smoother entry into the market. The strategy is most effective during volatile markets as it helps in averaging the cost of investment.
Experts say in the current market condition, it is advisable for investors to stagger investments into the equity markets through STPs over the next six to nine months. They should park money in low-risk liquid or arbitrage funds and can transfer a fixed amount each month. This will help them to take advantage of any interim volatility and average their cost of investment.
In fact, STP is structured to protect against downside risk in the short-to-medium term. For instance, a similar market correction occurred between October 2021 and July 2022, where the Sensex declined over 10% in 10 months. An investor who had invested `1 lakh in Nifty 50 index as a lump sum in October 2021 would have earned lower returns of 7% compared to 9% by an individual who used an STP to invest gradually over the same 10-month period. (See graphic)
Liquid, arbitrage funds for STPs
Investors should consider liquid funds and arbitrage funds for structuring their STPs. Currently, liquid and ultra-short-term funds offer 7% returns. Nirav Karkera, head, Research, Fisdom, says liquid funds provide low volatility and minimal risk of negative returns, ensuring capital stability while generating higher returns than a savings account. “This allows investors to earn steady returns before gradually transferring funds into equities, effectively managing market volatility,” he says. Moreover, the expense ratio for liquid funds is low.
STPs involve selling of parked fund units which are taxable. For investors seeking better tax efficiency, arbitrage funds can be a preferred option. While equity taxation applies to gains from arbitrage funds, liquid funds are taxed as debt investments based on the tax slab. So, those in a higher tax bracket will benefit more from using arbitrage funds for STPs.
However, investors must note that most arbitrage funds impose an exit load in the range of 0.4%-0.6% for the first month. To maximise tax efficiency while avoiding exit load charges, it is advisable to initiate the STP after the end of the exit load period. “We recommend investors to go with liquid funds for structuring STP but sophisticated investors with knowledge of derivatives spread can use arbitrage funds to improve STP returns,” says Karan Aggarwal, CIO, Elever, a wealth tech PMS.
Align STPs with financial goals
Before opting for an STP, investors should ensure alignment with their financial goals and risk tolerance. Soumya Sarkar, co-founder, Wealth Redefine, an AMFI registered mutual fund distributor, says assessing the investment horizon is crucial, as a longer duration can better accommodate market fluctuations and enhance the
benefits of rupee cost averaging. “Determining the frequency and amount of transfers is essential. More frequent transfers might be beneficial in volatile markets, while less frequent transfers could be more cost-effective,” he says.
By automating the transfer process, STPs promote disciplined investing, helping investors avoid the pitfalls of market timing. They are an effective way to mitigate volatility and optimise entry points into equities.