What is Systematic Transfer Plan? How does it work?
Investors can use Systematic Transfer Plan (STP) as a defence mechanism in volatile market. This plan is used to transfer investment from one asset or asset type into another asset or asset type. Read this space to know all about STP and how does it work?
Before we understand STP, let's define SIP (Systematic Investment Plan) first. SIP is a disciplined way of investing where investors invest a regular sum every month in mutual funds. SIP is also known as rupee cost averaging and it is the best way to handle volatility in investment. For example, you start to invest Rs 5,000 every month in a mutual fund. If you do it via SIP, this money will be taken from your account every month and invested in the mutual fund that you have selected for SIP.
STP is a variant of SIP. STP is essentially transferring investment from one asset or asset type into another asset or asset type. The transfer happens gradually over a period.
STP and its importance
Systematic Transfer Plan is of two types; fixed STP, and capital appreciation STP. A fixed STP is where investors take out a fixed sum from one investment to another. A capital appreciation STP is where investors take the profit part out of one investment and invest in the other.
Example of STP
Suppose you have invested 5 lakhs in debt funds because you thought market is trading at close to peak. The PE ratio of the market is 25 and hence you think that fall is imminent. Hence you invested your money in debt fund. Now assume that your prophecy was right and the market indeed fell to a level where you can make entry to equities. However, there are overall weak sentiments which may push market further down. What is the best strategy in this case?
You can take out 5 lakhs out of debt fund and invest in equity oriented mutual fund. The risk is that if the market goes further down, your fund value will also fall. This is a risky strategy. Moreover, if the weak sentiments prolong for some time, you will lose on the opportunity cost because your money is stuck with an investment which has gone down in value.
There is other way which can really minimize the risk. The way is called STP. In this case, you can withdraw a fixed amount from your debt fund investment and invest in equity oriented fund. This can go on for several months depending upon your choice. For example, if you want to continue STP for 3 years, you can direct your fund to do this and the fund will withdraw money automatically from your debt fund and put into equity oriented fund every month. What this strategy achieves is that it essentially acts as a defence against any adverse movement of the market.
You can see that even when the market is losing value at the rate of 1% per month, the STP plan has worked as a defence against the fall. Even after 12 successive falls, the return after 12 months is 9.56% which is quite good. Had this been done in a lump sum amount of 5 lakhs, here is the payoff. The investor has actually lost 11.36% over the same period. This is the advantage of STP.
The fundamental idea remains the same. The only difference in capital appreciation STP is that only the profit part of the investment is transferred in the other asset. For example, the investor has invested 5 lakhs in debt fund. In a month, suppose the return is 1%. This means that his investment has grown by Rs 5000. Investor will take out this money and invest in equity fund. This strategy is good for conservative investors who want to protect their principal and take risk with the returns.
Important points to keep in mind
STP is a possibly the second best investment strategy after SIP. It is one of the best risk mitigation strategies of the market. Investors though should keep the following points in mind.
First, STP is a risk mitigation strategy. It will protect you from any adverse loss to a large extent. Investors should be clear about this. All risk mitigation strategies cap the loss but also reduce returns when market is bullish.
Second, investors need to follow it with discipline. STP, just like SIP, benefits only when followed properly. Breaking STP because of short term market movement or interest rate movement will only harm your investment in long term.
Finally, you need to understand the assets and the stages they are in. For example, it would be unwise to transfer money from debt to equity when the market is closer to peak value. Similarly, it would be counter-productive to transfer money from equity to debt when the market is close to bottom.
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