As the stock markets are likely to remain volatile till the general elections, mutual fund investors should avoid investing lump sum amount in any particular equity scheme and instead invest through systematic transfer plans (STPs).
In STPs, funds are transferred from one fund to the another in the same fund house, ideally from debt to equity. However, an investor who is likely to retire soon, can even use STP to move money from equity to debt. In volatile market conditions, individual investors can stagger investments through STPs by investing a lump sum in debt, which could be a liquid or ultra short term fund, and then transfer a fixed amount either weekly, monthly or quarterly into a equity fund. Analysts say STP is a smart way to stagger equity investments, reduce short-term risks and gain high returns in the long run.
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Fund houses offer various types of STPs plans—fixed, flexible and capital appreciation. In a fixed scheme, a predefined amount fixed by the investor is transferred. In a flexible scheme, an investor can transfer different amounts from the source fund to the target fund depending on the market volatility. In capital appreciation, only the capital appreciated or the returns is transferred from source to the destination fund.
Liquid funds better than savings account
All asset management companies offer STPs to their investors. Ideally, liquid funds are better than bank savings account as the returns are higher and are very liquid. An investor can invest a lump sum amount in liquid fund which will earn returns of 7-8% a year. Then, though an auto instruction, a fixed amount will be transferred into equity funds.
There are very attractive opportunities in mutual fund debt schemes for retail investors, starting from overnight investment in liquid funds to duration debt products like gilt funds, income fund, dynamic bond funds, etc. Liquid fund schemes of mutual funds present an excellent opportunity to deploy your surplus money for a short period of time even overnight without losing on liquidity.
The proceeds of such schemes are invested by the mutual funds in good quality paper having adequate liquidity in the market. There is no exit load and investors can exit as soon as they want. Ultra short-term funds also provide quite similar benefits to investors for short-term deployment/ investments. In liquid funds, all fund houses offer instant redemption of Rs 50,000 or 90% of the folio, whichever is lower. So, it makes sense for investors to shift money from savings account to liquid funds as most savings accounts offer only 4% rate of interest whereas liquid funds yield higher returns.
Liquid funds—that can only invest in bonds maturing on or before 91 days —and ultra short term funds —that have investment time frame of 6-12 months—would typically generate returns marginally higher or in line with short term interest rates like those available on bank fixed deposits. They are ideal for an investment horizon of up to 12 months.
Transfer to equity funds
While looking for STPs, an investor should find out about the fundamentals of the fund house’s equity fund. Since the transfer will be done only within the fund house, investors should look at historical returns of the equity fund, investment basket and the track record of the fund manager to deal with various market movements. Like a systematic investment plan, an STP will also average out the cost by purchasing fewer units at a higher net asset value and more at a lower price.
Before finalising on an STP, an investor must understand the tax implications. Each transfer from a debt fund to an equity fund will be considered as a redemption and fresh investment. This redemption will be taxable as short-term capital gains tax (STCG).
Transfer from equity fund
As a part of retirement planning, one can transfer money from equity funds to less risky debt through STPs. Analysts say STP can be a great tool at a young age to move money from debt to equity and as one approaches retirement, they initiate an STP to prevent loss of fund value due to volatile markets. Such an approach will help an individual to move his accumulated corpus to a safer haven like debt.