Before we understand STP, let’s define what an SIP, or Systematic Investment Plan, is first. An 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 invest Rs 5,000 every month in a mutual fund. If you do it via an SIP, this money will be taken from your account every month and invested in the mutual fund that you have selected for the SIP.
The Systematic Transfer Plan (STP) is a variant of the SIP. It is essentially transferring investment from one asset type into another asset type over a period of time.
STP and its importance
Systematic Transfer Plans are of two types — fixed and capital appreciation. 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.
The fundamental idea remains the same. The difference in capital appreciation STP is that only the profit part of the investment is transferred to the other asset. For example, the investor has invested Rs 5 lakh in a debt fund. In a month, if the return is one per cent, it means investment has grown by Rs 5,000. Investors will take out this money and transfer it to an equity fund. This strategy is good for conservative investors who want to protect their principal and take a risk with the returns.
How does an STP work?
Say you have invested Rs 5 lakh in debt funds because you thought the market is trading at close to its peak. The PE ratio of the market is 25 and you think that a fall is imminent. Now assume your prophecy is right and the market indeed falls to a level where you can make an entry into equities. However, there are overall weak sentiments which may push the market further down. What is the best strategy in this case?
You can withdraw your Rs 5 lakh from the debt fund and invest it in an equity-oriented mutual fund. The risk, however, is that if the market goes further down, your fund value will also fall. Moreover, if the weak sentiments continue for some time, you will lose on the opportunity cost because your money is stuck in an investment which has gone down in value. There is another way which can really minimise the risk — the STP. In this case, you can withdraw a fixed amount every month from your debt fund and invest it in equity-oriented fund. This can go on for several months depending upon your choice. For example, if you want to continue an STP for three years, you can direct your fund to do this.
What this strategy achieves is that it acts as a defence against any adverse movement of the market.
Points to be kept in mind
* The Systematic Transfer Plan is a possibly the second best investment strategy after the Systematic Invest-ment Plan. It is one of the best risk mitigation strategies of the market. Investors, though, should keep the following points in mind
* It will protect you from any adverse loss to a large extent. But you have to be clear that all risk mitigation strategies cap the loss but also reduce returns when the 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 the long-term.
* Finally, you need to understand the assets and the stages they are in. For example, it would be unwise for you to transfer your money from debt to equity when the market bullish. Similarly, it would be counter-productive to transfer money from equity to debt when the market is close to bottom