There is always a risk involved while investing a big lumpsum amount in equities. In such a situation, investor seeking to invest in equities can take advantage of Systematic Transfer Plan (STP). STP enables investors to take exposure in equities while at the same time reaping benefits of the debt funds.
The systematic investment route for investment in mutual funds is ideal when you want to make investments on a monthly basis in mutual funds. For the bonus/windfall gains that you may receive, you can use the systematic transfer route which will enable a de-risked mode of investment.
Understanding the mechanism
Explained below is the mechanics of this mode of investment -
Under the systematic investment plan, the investor typically has a lump sum amount to invest. Considering that investing in equities at one go could be risky, one could choose to park the funds in highly liquid and cost efficient debt funds such as liquid plus/floating rate fund, and on a regular basis, transfer a stipulated amount into equity funds..
This would provide the funds efficient returns from debt (instead of funds lying idle) and enable automated transfer into equity fund on a regular basis, which will reduce the downside risk significantly.
Systematic transfer plans need not be conducted from debt to equity as a rule; one may use a combination of gold/equities as per ones preference, however, the logic of investing via systematic route suits best when one involves debt and the transfer happens into Equity/Gold with a view to curtail the downside.
The scheme from which the transfer takes place is called the 'source scheme' and the scheme into which funds are transferred is called the 'target scheme'. The STP mode of investment saves the time and effort involved in giving multiple instructions to the mutual fund to redeem from one scheme and invest in another and converts it into a single instruction, to be executed over the defined period. Besides, it gives the investor an opportunity to earn a better return as compared to returns from a savings bank account, from liquid funds or short term bond funds that are used as 'source scheme'.
Paperwork & Process
Mutual funds provide a bouquet of dates in a month and frequencies for carrying out the STP. Investors can choose a specific date and the required frequency (daily, weekly, monthly, or quarterly). Apart from filling the common application form for the debt fund, one has to fill the systematic transfer plan as well which would instruct the mutual fund house to transfer the stipulated amount on a particular date, frequency and for the specified period as chosen. Fund houses usually mention a minimum investment amount in the target scheme for investors to avail the STP facility, they also mention the minimum installments of transfer for STPs which is typically 6 - 12 installments.
Types of STPs
Fixed STP is one where fixed amounts are regularly transferred from the source scheme to the target scheme. In a capital appreciation STP, only profits in excess of a predefined amount are transferred to the target scheme. Most investors use the fixed STP which is easier to understand and more convenient.
Tax angle on STPs
If one were to invest via the systematic transfer plan, the exits from the debt fund (or any other fund as prescribed) will be subject to tax. If the source scheme is a debt fund, then the short term capital gains will kick-in on exit from this fund (if the exit is done within the 12 month period), the taxability in this respect would be as per tax slabs. If the exit happens after 12 month holding period, (which is typically rare), the gains would be taxed at 20% post indexation benefit or 10% without indexation benefit; in both cases cess @ 3% is applicable. The gains from Debt fund would be on the lower side, one should ideally opt for the dividend option in this scheme. The redemptions from destination fund (which is normally the equity fund) would be taxed as per the standard tax rules - short term capital gains @ 15% + cess of 3%; long term capital gains is exempt from taxes.
Difference between SIP, STP and SWP
Systematic Investment Plan: Every month a fixed sum is debited from your bank and invested in a Mutual fund.
Systematic Transfer Plan: Amount is invested upfront in the source fund and will undergo a systematic transfer (stipulated amount, at suggested frequency on a specified date) into the target fund.
Systematic Withdrawal Plan: If one were to withdraw a specified amount for a certain period at a pre-determined frequency, then one could term it as SWP arrangement. Typically used as a popular retirement mechanism to fund pension amount.
This article hopefully will give you an idea of the benefits of systematic transfer plan. And now you perhaps know the best way to go about investing the annual bonus!
The author is CEO & Founder of Right Horizons. He can be reached at firstname.lastname@example.org