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  4. Systematic transfer plan (STP) – how to use it right!

Systematic transfer plan (STP) – how to use it right!

When you have a large sum to invest in, you have been told, it is best to systematically transfer it using what is called the Systematic Transfer plan (STP). This does exactly what an SIP does, except that the money to be invested, in this case, does not lie in your savings bank account. It lies in a fund. Also, unlike a SIP, where you typically invest from your monthly savings, in STP you simply deploy the lumpsum that you already hold.

So far, so good. But for how long should you run this STP? Which funds do you go for? And should you always use an STP when you have a lumpsum?

Please note that this article is for those who aren’t familiar with STPs. Experienced investors can skip it. We’ll see you in the next one!

systematic transfer plan, STP

What an STP does

Systematic transfer plans involve investing a sum in a low-risk fund and periodically shifting a fixed amount from this fund into another. Here’s breaking it down:

  • You need to decide two aspects – the time frame for which you will run the STP and the periodicity with which you switch from one fund to the other. For example, you can run it for 12 months with monthly switching, or with weekly switching.
  • The shift from the source fund to the destination fund happens over the course of this period. The source fund is redeemed to the extent of the fixed amount every month/ week according to the frequency you have set. So, you will have to pay capital gains tax on the redeemed amount. 
  • The balance that remains in the source fund will generate returns. This is why you will often see some amount remaining in the source fund even at the end of the STP period. Such an amount can be switched one time into the destination fund to ensure the full amount is switched. 
  • The source fund and the destination fund (or funds) need to be from the same AMC for an STP to run automatically once you set it up. If you’re going to hold funds from different AMCs but want to use the concept of an STP, you will have to redeem from funds and reinvest in funds each month yourself. It’s cumbersome, but doable (or it is possible that your platform has a mandate to do that for you. We can’t be sure about this).

Where an STP helps and where they don’t

You use an STP the most when you have a large surplus (say over 10-15% of your existing portfolio) to invest. By doing an STP you achieve three broad objectives:

  • One, deploying this amount at one shot could open up your portfolio to timing risks. STPs help spread out investments across the months, in order to mitigate the risk of mistiming. Two, unlike a SIP, the source fund in the STP generates returns for you. This return, in most cases, will be better than what your savings bank account would deliver.  So, you earn better on your initial corpus, while you average. 
  • The third objective an STP achieves is more behavioural. Should you let your surplus remain in your bank account, it may be hard for you to track your spending and you may inadvertently use up what you should have invested. An STP ensures that you remain invested as you originally intended.

But don’t jump blindly for an STP as soon as you have a lumpsum to invest. As explained above, STPs are for risk-mitigation where volatility and chances of investing at peaks are high. Therefore, STPs make a bigger difference in some types of funds and some scenarios than others:

  • STPs are the most useful when you intend to invest in equity funds. And we mean all equity funds (unless they’re thematic that need timing) across categories. Risks of steep corrections suppressing returns and investing at highs are rampant primarily in these funds. Second, for STPs (or SIPs) to work in averaging costs, you need volatility and different price points. That again is predominant in equity and hybrid aggressive funds. 
  • STPs help when equity markets are correcting. As a continuation of the point above, if equity markets are in a corrective phase, STPs are extremely useful in picking up opportunities at lower price points. 
  • STPs don’t help average costs on the downside when equity markets are in a steady rally, as every STP investment made in an equity fund will be at higher levels. The STP will therefore be averaging your costs higher. But then, remember, like an SIP,the STP at its core is done to avoid timing efforts. There’s no way you will know if markets are going to correct or rally once you invest – and this is precisely why you do an STP. 
  • STPs don’t help in debt funds, unless you’re approaching your goal. If you’re planning on lumpsum investing in debt funds, you can go ahead and do so without worrying about STPs. For one, accrual-based debt funds are not volatile – they do not lend themselves to ‘cost averaging’ much nor is it risky to make lumpsum investments. In duration-based debt funds, you can see volatility due to bond yield movements. However, this volatility is not deep enough to warrant phased investments through STPs. Also, unlike a SIP, which is done for a longer period, the STP duration may not be sufficient to make any meaningful averaging even in duration funds like gilt or dynamic bond. You could invest through STPs when rate cycles are at the cusp of turning upward, if you’re extremely wary. Else, it’s fine to avoid STPs. And remember, your debt returns are by themselves in single digits. Paying taxation on the source fund and again high taxation on the destination debt fund only reduces the tax efficiency and lowers net returns. 
  • STPs may help in some hybrid funds. In most hybrid categories – conservative hybrid, arbitrage and equity savings, the same reason as explained for debt funds hold. The low volatility and low risks of wrong timings means that you needn’t run STPs in them. However, hybrid aggressive funds are similar to pure equity funds in terms of timing risks. In these funds, you can run STPs. In the balanced advantage/ dynamic asset allocation category, the call is hard as some funds are more volatile than others. Go the lumpsum route if you can take small hits. Otherwise choose STP. 
  • If you’re nearing your goal, STPs help even if you’re investing in debt/low-risk funds. STPs don’t always have to be from debt/low risk funds to equity/high-risk funds or for lumpsums. Running STP from equity to debt is a good strategy when you are approaching your goal. In these cases, you’re not investing lumpsums. Instead, you are protecting gains you’ve already made. By shifting gradually from equity to debt, you lock into gains as well as retain some participation in equity returns.
  • When liquid fund returns are low, then the return benefit that the STP provides may not be much. Liquid funds are the best suited for STPs (we’ll see why later on). When yields are low as they are currently, returns may not be much better than savings bank. The average 1-year return for liquid funds has been below 5% for the past year, and has slipped to about 3-3.5% now. If your savings bank account is among those that pay out higher rates, you could actually be better off running an SIP from your bank instead of an STP – provided you have the discipline not to spend the money.
  • Finally, you do not need to wait for an STP to complete. You set up an STP for a certain period. There’s no compulsion that you run the STP for the entirety of this period. You can always make one-time switches into your equity fund when opportunities present themselves, in addition to the STP you’re already running. For example, even in rallying markets, there could be a sudden dip that you can use to your advantage. In volatile or correcting markets, making lumpsum switches on steep slides can be used to enhance the benefits of the STP. This means that your STP completes earlier than you planned, but you’ve taken advantage of market movements.

Apart from those explained above, there are other conditions where you need not run STPs and where you can simply make one-time investments. These are explained in detail in our article on when it is fine to make lumpsum investments.

How long to run STPs?

This is where it starts to get tricky. There is no one-size-fits-all approach that you can take when determining your STP period. Here are some guidelines. Please note that you should tailor these to fit your needs. You can go in for monthly frequency for the STP. You can make it weekly if your investment amount is large, but note that high frequencies don’t always translate into better returns as explained in this article.

#1 When your holding timeframe is at least 5 years

This is when STPs are the most useful.

  • If the surplus you have in proportion to your portfolio value or the amount you hold in the planned fund is large, then run longer STPs. This is because your fresh investments will have a greater impact on your investment costs. The opposite holds if the proportion you plan to invest is low compared to your existing investment – in these cases, you can run short STPs of 6-8 months.
  • If markets have been rallying for a few months, and market commentary does not suggest a bubble or volatility cropping up, keep your STP period on the shorter side. This can be anywhere between 6-15 months, depending on the amount you’re investing (see point above). But don’t let it run for very long periods, as it can simply keep averaging your costs higher if no correction sets in.
  • If markets are already in a corrective phase – i.e., they have been trending lower, then let the STP run for 6-12 months but be prepared to make quick lumpsum switches on days when markets fall particularly hard.

#2 When your holding timeframe is 3-4 years

In such cases, you may have two scenarios – one, you already have a long-established portfolio, with your goal being just a couple of years away and you’d like to withdraw from equity. Here, keep STP periods short to 6-12 months. This will help protect your portfolio from sudden market corrections especially if markets have rallied long. We’ve earlier covered how you should approach your investments when your goal draws near in detail.

In the second scenario, your timeframe is 3-4 years away and you have a surplus to invest. For the STP, keep STP periods short at around 6 months. For starters, your holding timeframe itself is short; running very long STPs won’t give your investments time to work. And asset allocation principles anyway demand that you keep your equity low for such short time frames.

#3 When your holding period is less than 3 years

Again, the first scenario of an approaching goal as explained above can hold here as well. In such a case, the same STP period will work. In a scenario where you need to make fresh investments – well, the timeframe is too short to allow investing in pure or aggressive equity funds or even duration-based debt funds. Therefore, you don’t really need to run STPs. Simply make lump-sum investments in debt funds.

What source funds to use for STP?

We’re considering only fresh investments for this question, and not shifts away from equity as you approach your goal. For an STP, the source fund has to be low on risk and volatility. 

Capital protection takes the first priority here. For one thing, the reason for an STP is to phase out investments in high-returning, high-risk funds. Investing in volatile funds would run counter to the STP concept. For another, using riskier funds for the STP’s source fund means that you could be inadvertently redeeming at losses. Third, several funds in these categories come with exit loads.

Equity funds are a strict ‘no’ as ‘source fund’ option. Categories such as aggressive hybrid, equity savings, conservative hybrid and balanced advantage funds are also avoidable. Any sharp market correction can send even 1-year return for these funds into the loss-making zone. Both conservative hybrid and equity savings funds, for example, delivered 1-day losses 40% of the time and were loss-making 25% of the time even on a 1-month basis.

Debt fund categories that can see volatility due to bond yield movements or those that take credit risk are also poor source fund options for STPs. This includes most debt fund categories that have maturities longer than a few months. The table below shows the proportion of times some key debt fund categories have delivered losses in 1-day, 1-month and 1-year periods over the past 3 years.

This leaves overnight funds, liquid funds, and arbitrage funds. The first two are low volatile, low risk, and rarely deliver losses even on a 1-day basis. Arbitrage funds may be low risk as the full equity exposure is hedged and they offer tax advantages. But see the table below.

Arbitrage funds do clock losses on a day-to-day basis and can be loss-making on a 1-month basis as well. Funds have dropped as much as 0.33% on a 1-day basis; markets such as we saw in early 2020 had several arbitrage funds deliver losses for several days in a row. This characteristic makes them unsuitable for STPs. If you’re willing to take the risk in exchange for the tax benefit –that’s a call you need to make. 

In our view, overnight and liquid funds are the best for STPs. Apart from their low volatility and risk, given the limited scope of their investment universe, performance difference between funds is minimal. This removes the risk of choosing a source fund with poor performance.  You can instead focus on the right destination fund for you and simply stick to the source fund from the same AMC. 

To summarize, STPs are useful when investing in high-risk funds where timing investments wrong can hurt. You need to have a reasonable idea of how long to run an STP and which source funds to use. You use safe funds to make the transfers. Your returns come from the fund you’re shifting into and not the fund you are shifting out of.

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