How to use STP during market volatility
More than a SIP, a STP can help you invest efficiently during the volatile phases of the stock market. It can even help reduce risks associated with equity investments.
As the stock markets have been volatile for some time now, investors don’t want to invest lumpsum amounts in the stock market. However, there are many who feel the markets have a lot to offer whenever there is a downturn. So, how can you invest to make the most of the low-priced stocks available on the stock market? The Systematic Transfer Plan (STP) can help.
How does STP work?
In STPs, the money that you have invested will be transferred from one fund to another in the same fund house. This transfer is usually made from debt funds to equity funds. When the markets turn volatile, retail investors can stagger investments using STP. How? You will need to invest a lump sum in a debt fund. This could be a liquid or ultra-short-term fund. Once you do that, you can transfer a fixed amount from the debt fund to an equity fund of your choice. This transfer can be done either weekly, monthly or quarterly.
How does STP help?
Transferring money at regular intervals to equity will make sure that your investment costs get averaged out over the long term. The costs will be much lower hen compared to investing a lumpsum in equities. Staggered investments will help reduce short term risks to your investments because of market crashes.
How is STP different from SIP?
For Systematic Investment Plans (SIP), you transfer money from your savings account to your investments. When you use STP, you are transferring money from a debt fund which will earn you much higher returns than a savings account that gives you just 3%. So, while your money remains in debt funds, it continues to earn more while you wait to invest in equity funds. So, the total return from your investments will be much higher from STP investments in an equity fund than investing using SIP. STP can help you maximize the returns on the lump sum amount lying in your bank savings account.
Which debt funds should you use for STP?
Liquid funds are better than bank savings account as they provide higher returns and are quite liquid. You could invest a lump sum amount in a liquid fund which will earn returns of 5%-6% a year. There is no exit load. So, you can exit anytime you need to. Using auto debit, a fixed amount can be transferred to an equity fund from the liquid fund. Liquid funds invest in securities with maturity of less than 91 days. So, they are highly liquid.
Most fund houses provide instant redemption for liquid funds. This is for investments of Rs. 50,000 or 90% of the folio, whichever is lower. So, it makes sense for investors to use liquid funds to invest in equity funds if they want to benefit from STP. Ultra-short-term funds also provide higher returns than savings account as they invest in fixed-income securities having time horizon of 6 months to one year. If you have a longer time horizon, there are many other debt schemes that you could consider. These are gilt funds, income funds, dynamic bond funds, etc.
What are the types of STP offered?
Fund houses have three types of STPs—fixed, flexible and capital appreciation. In a fixed STP, the amount and frequency of investment in the equity fund is fixed. Under a flexible scheme, you can transfer different amounts from the debt fund to the equity fund depending on the market volatility. Whenever the Net Asset Value (NAV) of the equity fund is low, you can invest more. If you go for a capital appreciation STP, only the capital appreciation or the gains are transferred from the debt fund to the equity fund. The capital remains as it is in the debt fund.
What are the points to note?
Even though there is no minimum investment for STP, some fund houses might set a minimum of Rs. 12,000 for transferring money to the equity fund. Also, note that there might be no entry loads. However, exit loads might be applicable.
Which equity fund to choose for STP?
Since the transfer can be done only within the fund house, you should look at all the equity funds offered by the fund house. You will need to consider the fundamentals of the equity fund. Look at the historical returns of the equity fund, its portfolio and the track record of the fund manager before zeroing in on an equity fund.
What are the tax implications?
Every transfer you make from a debt fund to an equity fund will be considered as a redemption and a fresh investment. While investments don’t have taxes, the redemption will be taxable as short-term capital gains (STCG).
STP is not only useful to those who want to invest in equity, it will be useful to retirees as well. Senior citizens can transfer money from equity funds to debt funds using STP, especially when they want to preserve their capital gains. STP will help prevent loss of capital due to volatile markets.