Currently, many mutual fund investors are finding it difficult to continue their SIPs because of cash crunch. They, therefore, may find STPs to be useful.
The Systematic Investment Plan (SIP) is a popular way to invest in mutual funds, but are you aware of another smart tool called the Systematic Transfer Plan (STP)?
While an SIP allows you to invest in mutual funds in instalments when the money is transferred from your bank account, in an STP, the money is transferred from one mutual fund plan to another within the same mutual fund company. If you have a lump sum amount for investment, you can’t wait for several months to invest it through SIPs. Also, a lump sum investment in equity funds can be highly risky. So, mutual fund companies allow investors to systematically transfer a fixed sum from an investment in one scheme to another through an STP. The fund in which the lump sum amount is invested is also called a source mutual fund scheme, and the fund to which a fixed amount is transferred is called the target scheme.
In the current situation, many investors are finding it difficult to continue their SIPs because of cash crunch. They, therefore, may find STPs to be useful because they can use one of their existing investments as a source to invest in another scheme. Let’s first check out some of the key features of STPs to better understand how they can benefit mutual fund investors at a time like this.
Key features of STPs
STPs can be done from a debt fund to an equity fund or vice-versa. When the equity market is down, it might be a better idea to use STPs as a tool to gradually switch your investment from debt to equity to earn a higher return when the equity market bounces back. Similarly, when the equity market is at its peak and you want to lock-in the returns to avoid the risk arising out any downward correction in the market, you can use an STP to switch from an equity scheme to a debt scheme.
You need to make at least six capital transfers from one fund to another in an STP. It may lead to an exit load up to 2% while the entry is free from charges. When you transfer funds from one fund to another, each transfer is considered as a redemption, and if there are any capital gains, they will be subjected to tax depending on the nature of the fund. Long-term capital gains (LTCG) on debt funds are taxed at 20% with indexation benefit whereas short-term capital gains (STCG) are taxed at the applicable slab rate. LTCG up to Rs 1 lakh on equity funds are tax-exempt whereas LTCG above Rs 1 lakh in a financial year are taxed at a 10% rate. STCG on equity mutual funds are taxed at a 15% rate. So, while deciding about STPs, it’s crucial to assess the tax impact on your returns.
How can you benefit from STPs in the current situation?
The equity markets have been quite volatile during the prevailing Covid-19 crisis. In such a situation, the average investor might not be able to time his investments. Also, many people are facing difficulties in continuing their SIPs due to Covid-fuelled pay cuts, job losses or diminishing business income. However, if they stop the SIPs, they may not benefit from rupee cost averaging when the equity market falls. So, they can opt for an STP instead from their existing investment in debt funds to invest in an equity scheme. They may also use an STP to transfer a portion of their investment in an existing fund to a liquid fund to create an emergency corpus to overcome their financial challenges.
In the current market, people who are afraid of making a lump sum investment can invest their fund in a debt fund and, at the same time, use STPs to invest in an equity scheme. This will allow investors to reduce losses if there is a sudden fall in the equity market while allowing investors to minimize the risk by investing in equity mutual funds in a staggered way.
Now suppose you are approaching retirement and have already accumulated your retirement corpus. In that case, you can protect your corpus from market volatility by using STPs to transfer funds from equity to debt schemes.
In conclusion, STPs should be used as a tool to maintain the right balance between your investments in equity and debt mutual fund schemes, to reap maximum returns, and to reduce investment risks. However, you must make informed decisions when it comes to determining the portion of your invested capital in a particular fund that needs to be transferred to another so that you can earn good returns while keeping investment risks under control. Don’t hesitate to consult a certified investment advisor if you find it difficult to make a decision related to STPs.
(The writer is CEO, BankBazaar.com)