Mutual Funds: What is a systematic transfer plan and how to set up it?

A Systematic Transfer Plan (STP) in mutual funds involves transferring a fixed amount or units from one mutual fund to another at regular intervals, typically from debt funds to equity funds. This strategic approach aims to manage risk, achieve investment goals, and potentially enhance returns by averaging purchase costs and reducing market volatility.

STP enables seamless and periodic transfers between mutual fund schemes within the same asset management company, optimising resource utilisation and enabling effective portfolio management. Transfers between schemes offered by different companies are not allowed under this strategy, emphasising the need for careful selection within a single provider’s portfolio. 

Here’s an in-depth look at everything you need to know about STPs in mutual funds:

Types of STPs

Fixed STP: A fixed amount or number of units is transferred at each interval. In this case, the total amount to be transferred from one mutual fund to another remains fixed, as decided by the investor.

Flexi STP: The amount can vary based on market conditions or predefined criteria. The total funds to be transferred are determined by investors as and when the need arises. Depending upon market volatility and calculated predictions about the performance of a scheme, an investor may want to transfer a relatively higher share of his/her existing fund, or vice-versa.

Capital appreciation STP: Only the capital appreciation (gains) from the source scheme is transferred to the target scheme. The total gains made from market appreciation of a fund to another prospective scheme with a high growth potential.

Advantages 

Rupee cost averaging: STPs enable investors to regularly transfer a fixed amount from one mutual fund scheme to another, such as from debt funds to equity funds. This systematic approach helps in averaging out unit purchase costs over time. By investing more when fund prices are lower and less when they are higher, STPs reduce the impact of market volatility and potentially enhance overall returns.

Risk management: During market instability, STPs allow investors to shift funds from higher-risk equity funds to lower-risk debt funds. This helps in managing risk by preserving capital and ensuring stable returns in volatile market conditions.

Optimised returns: STPs facilitate a balanced approach to investing by starting with safer debt instruments and gradually moving towards higher-return equity instruments. This strategy aims to leverage market fluctuations to optimise portfolio performance while catering to different risk appetites.

Tax efficiency: STPs can be used for tax planning by strategically transferring funds between mutual funds with differential tax treatments (like debt and equity funds). This structured approach helps in minimising tax liabilities and optimising overall portfolio management.

Discipline and convenience: By automating the investment process, STPs promote disciplined investing behaviour. Investors can set up regular transfers at predefined intervals, reducing the need for manual intervention and ensuring consistent contributions towards long-term financial goals.

Disadvantages

STPs significant concern is the market timing risk inherent in STPs, as they aim to average out unit purchase costs but cannot fully protect against market volatility. Adverse market conditions during transfer periods can adversely affect returns.

Additionally, exit loads and transaction costs imposed by mutual funds can reduce overall returns, particularly with frequent or short-term transfers. This may diminish the cost-effectiveness of using STPs.

During bullish market phases, lump sum equity investments often outperform gradual transfers via STPs, potentially resulting in missed opportunities for higher returns.

Tax implications are also notable, with each STP transfer involving redemption and reinvestment, potentially triggering tax liabilities based on holding periods and fund types. Effective tax management is crucial to optimising returns.

Managing multiple transfers and adjustments adds complexity, requiring vigilant monitoring to ensure alignment with investment goals and responsiveness to market changes.

How to set up an STP

Choose the right schemes: Select both the source and target schemes based on your investment goals, risk tolerance, and market outlook. Typically, a low-risk debt fund is chosen as the source, and a high-risk equity fund is chosen as the target.

Determine transfer amount/units: Decide on a fixed amount or number of units to transfer regularly. This should align with your financial goals and investment strategy.

Select the right frequency: Choose the transfer frequency that suits your needs (daily, weekly, monthly, quarterly). Monthly transfers are most common, but the choice depends on market conditions and personal preference.

Submit the STP form: Fill out and submit the STP form provided by the mutual fund house or through your investment platform.

Consider tax implications: Understand the tax treatment of your investments. Transfers under STP can have tax implications based on the holding period and type of funds (equity or debt).

Exit strategy: Have an exit strategy in place for the target scheme. Know when to stop the STP and whether you want to hold, redeem, or reallocate your investments in the target scheme.

Example of an STP

Scenario: An investor wants to move ₹ 9 lacs from a debt fund to an equity fund over one year, using a monthly STP.

1. Source scheme: Debt fund
2. Target scheme: Equity fund
3. Transfer amount: ₹75000 per month
4. Frequency: Monthly

Process: On a specified date each month, ₹75000 is transferred from the debt fund to the equity fund. This continues for 12 months until the entire 9 Lacs is transferred.

Conclusion

STP is a strategic tool in investment management, offering benefits like risk mitigation, rupee cost averaging, and enhanced returns. It allows gradual transfer from lower-risk debt to higher-yield equity funds, balancing risk and growth potential.

However, drawbacks include market timing risk, transaction costs, and varying tax implications. To maximise benefits, investors should select suitable mutual funds aligned with their goals, monitor performance, and adjust strategies as needed. Despite challenges, STPs provide structured portfolio management and disciplined investing, requiring careful planning and monitoring for long-term success and optimised financial outcomes.

Rohit Gyanchandani is Managing Director at Nandi Nivesh Private Limited