Investing in mutual funds demands a proper strategy to manage risk and returns. One such strategy to manage investments is the Systematic Transfer Plan (STP) that facilitates a gradual transfer from one mutual fund scheme to another to better manage risk. But how does STP in mutual funds function, and what are the reasons to opt for it? Let’s find out.
What does STP in mutual funds mean?
An STP is a facility that lets investors transfer a fixed amount from one mutual fund scheme to another at regular intervals. It is quite commonly used to move funds from low-risk debt to high-growth equity funds or the other way round basis investment goals and market conditions.
- Debt to equity STP: Used when markets are expected to rise, helping investors enter equity gradually while minimising timing risks.
- Equity to debt STP: Suitable when markets peak, allowing investors to lock in profits and shift to safer assets like debt funds.
How does STP in mutual funds work?
STP in mutual funds allows investors to manage their portfolios effectively. Here’s how it works:
Investment in a source fund
Before initiating an STP, an investor places a lump sum amount in a source fund—either a debt or an equity fund, depending on the objective.
- Debt-to-equity transfer: Investors park funds in a debt fund to earn stable returns while gradually moving into equity, reducing market timing risks.
- Equity to debt transfer: Investors move funds from equity to debt when they anticipate a market correction, wish to secure gains, or need liquidity for financial goals.
Regular transfers to a target fund
A fixed amount is transferred from the source fund to the target fund at predefined intervals, thus ensuring a systematic investment approach.
- Debt to equity: Helps investors take advantage of rupee cost averaging, reducing the risk of investing a lump sum at market highs.
- Equity to debt: Locks in equity gains while providing stability through debt investments, quite ideal for conservative investors nearing financial goals.
Choice of frequency
Investors have the liberty to choose how frequently the transfer occurs. Some common options include:
- Daily STP – Best suited for those who want a seamless transition with bare minimum risk exposure to market volatility.
- Weekly STP Provides a perfect balance between risk management and faster exposure to market opportunities.
- Monthly STP – Tends to be the most favoured option for investors looking for a structured long-term strategy.
- Quarterly STP – Definitely ideal for those who prefer a slower transition, particularly when moving from equity to debt.
The choice of frequency is also basis investment goals, market conditions and risk tolerance.
Tax implications
Since each transfer is considered a redemption from the source fund and a new investment into the target fund, tax implications apply.
- Debt to equity: Gains from the debt fund are taxed as per the income tax slab.
- Equity to debt: Gains from equity investments are taxed based on Short-Term Capital Gains (20%) or Long-Term Capital Gains (12.50% above ₹1.25 lakh).
Market risk management
STP mutual funds help manage market risks by avoiding lump sum investments at the wrong time.
- Debt to equity: Reduces the risk of investing at market peaks, ensuring a steady approach to wealth creation.
- Equity to debt: Prevents losses during market downturns by shifting funds to a safer asset class.
Better returns & liquidity
STP in mutual funds ensures optimal capital utilisation while maintaining liquidity.
- Debt to equity: Allows the lump sum to earn returns in a debt fund before full equity deployment.
- Equity to debt: Helps investors preserve profits while keeping funds accessible for future needs.
Ending note
An STP is a great option for investors who wish to invest in mutual funds strategically. Whether changing from debt to equity for growth or equity to debt for security, STP provides a hassle-free, convenient transition that is in line with market conditions and financial objectives. This strategy ensures generation of wealth while avoiding investment risks.