How Does Systematic Transfer Plan (STP) Work?

We all know how systematic investment plan (SIP) works. You put a small sum each month into equity funds and it has the potential to grow into a big corpus at the end of 15-20 years. Consider the table below:

It is quite clear that the SIP can really generate wealth in the long run. In fact, the longer you hold the SIP, the greater the wealth creation. A SIP works perfectly well when you have a regular income, but what if you have received a lump sum of Rs.20 lakh from the sale of a property in your village. How do you invest this money?

Challenges of Lump-Sum Investing

• If you plan to invest this lump sum money in an equity mutual fund, there are 3 key challenges that you will face.
• You will have to get your timing of buying the equity fund right. For example, if you had bought equity funds at the peak of the 2007 bull run, then it may have taken you at least 8 years to break even. Finding the tops and bottoms are a big challenge.
• Market volatility will work against you since once the money is invested it idles in the equity fund. If there are corrections in between, you are not able to take the full advantage of these corrections.
• In case you are waiting for opportunities, where do you park your money. If you leave your money in your savings bank account then you just earn 4% return and that is an extremely uneconomical usage of your funds.
• Is there a method to address all the above 3 problems. The answer could lie in a systematic transfer plan (STP).

What Exactly Is The Systematic Transfer Plan (STP)?

STP entails a very intelligent structuring of your lump sum money in such a way that you get the benefit of SIP, make the best of the market volatility, do not worry about identifying tops and bottoms and also make productive use of your idle money. Here is how a STP works in practice. The entire lump-sum amount of Rs.20 lakhs is invested in a liquid fund which yields approximately 6% per annum. The reason we have selected a liquid fund is that it does not entail any exit load making it easier to sweep money out of the fund. Also, the STP is structured as principal plus return so the tax on short term capital gains (STCG) is payable only on the return portion, which is very minimal. Each month a fixed sum of money is swept out of the liquid fund into an equity fund

The way the STP has been structured is quite interesting. The entire funds are invested in a liquid fund yielding 6% per annum. Then the entire corpus is transferred into an equity fund through an STP. The balance left in the liquid fund continues to earn returns at 6% per annum and you get the additional benefit of rupee cost averaging.

How Does The Investor Benefit From This STP Approach?

• There are a few obvious benefits that flow from this STP approach to investing your lump sum money.
• The idle money that is not invested will stay in a liquid fund and that continues to earn 6% return per annum. With zero exit load and minimal tax on capital gains, this is more efficient than a 4% savings deposit where your interest is taxed at 30.9% (peak rate).
• Since you are spreading your investment of Rs.20 lakhs over 2 years, you get the benefit of rupee cost averaging. The volatility over the next 2 years will automatically work in your favour.
• Now let us look at returns. Assume that your equity fund yields returns of 15% annually in the next 2 years. So your equity SIP of Rs.88,500 per month will grow to Rs.24.90 lakhs at the end of 2 years.
• Effectively, your annual yield on the funds in the last 2 years has been 11.55% CAGR. Now you have a corpus of Rs.24.90 lakhs invested via STP in the equity fund with the benefits of rupee cost averaging and the benefits of smart usage of idle money combined.

A STP is essentially like hitting two birds with one stone. It gives you all the benefits of equity SIP and at the same time also makes efficient use of idle funds.