STP or Systematic Transfer Plan is a method whereby, instead of investing your money in a Lump-sum manner, you invest in a single fund (Liquid Debt Fund) and instruct the fund house to keep on transferring a certain amount on a fixed date to another scheme of the same fund house, generally an equity one.
It is similar to SIP with the difference that the outflow of money is not from your bank but from a fund. Hence, the name Systematic Transfer Plan and not a Systematic Investment Plan.
This is usually preferred by investors who are concerned that the market might fall and hence, instead of going with Lump sum they choose a method to invest gradually.
So, is STP better than Lump-sum? Let us evaluate this.
Cost Averaging during Volatility:
STPs work just like our SIPs when it comes to taking advantage of the Cost Averaging Method i.e. if our investments go into a high market we would get fewer units due to a higher NAV, in a down market the same investment amount would help us in purchasing more units which in the long run would benefit us when the market would move up.
STP amounts can be increased or stopped by informing the fund house. Therefore, you have the flexibility of going all in times of opportunity or completely staying away from the market if you feel the time is not right to enter the market.
Equities are meant for long term. However, with a sudden drop in the market in the short run, there are people who, irrespective of their risk profile, find it difficult to hold on their investments with a long-term horizon. For such investors, STP helps in maintaining that psychological balance with their investments entering into the market in a gradual manner rather than going all in.
Taxation & Exit Loads:
STP works like redeeming the money from one scheme and investing in another. Hence, the exit loads and taxation on the scheme from where the STP is done would be applicable.
Will STP generate more returns than Lumpsum?
The answer to this one is a classic – It depends.
The logic behind STPs performing better than Lump sum Investments lies in a simple belief that the market will be volatile during the time of STPs. This, in turn, will help in getting more units as our investments were made in the down market. Hence, our portfolio will generate generous returns with a higher Compounded Rate of Return (Compounded Annual Growth Rate – CAGR)
But the question is – Do the markets follow the same logic as ours?
Of course not, else we would have all been making money on our every investment with a 100% success rate. If the markets do not fall while the STPs were being done, the result would be that the Lump Sum option would have delivered better returns.
Therefore, is STP the best way to go in an every market condition – probably not. However, if you believe the market would be uncertain for quite some time (since we cannot judge the short-term market phase) it is better to go with STPs.
To be honest there are people for whom the STP route has worked whereas there are others who have played better with Lump-sum. Therefore, the verdict is not that general.
If you are among the ones who would not worry about short-term volatility and are comfortable with investing systematically from your bank account to the Mutual Funds and assure yourself that you would not spend the money elsewhere, I believe you do not need STP to deliver high returns. If you, unlike the one I mentioned, you can go ahead with STP. Whichever path you follow, always remember that you should definitely invest in Equity Mutual Funds if you have a long-term horizon whether you do it Systematically or not.