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Since 2012, it has been a range-bound and fairly volatile time for the equity market. And though we ended 2012 on a high, the seesaw in the interim could have driven many an equity investor away. This is a pity, since those who stayed would have lost out on the 25%-plus return the market generated last year (illustratively, if they'd invested in the beginning of the year).
There's a lesson in this for most of us — even the smartest investors cannot time the market accurately. Therefore, the best way to deal with this is to ensure disciplined investing, irrespective of market conditions.
One of the most widespread and successful ways of doing that is through a systematic investment plan (or SIP as it is commonly known). The key benefits of SIPs, namely rupee cost averaging, compounding of returns and a disciplined approach to investing, are known to most investors.
Today, however, we will talk about systematic transfer plan (or STP) — an approach also based on the same principal as SIP, but, if utilized well, it can potentially lead to better returns.
As the name suggests, an STP is a facility that is offered by mutual funds to their investors to periodically transfer their investments from one fund to another. While the fundamental idea between an SIP and an STP is similar — that is investing small amounts regularly irrespective of market conditions — an STP also allows the investor to periodically switch funds between different asset classes. For example, the investor can hold funds in a low-risk debt fund and regularly shift part of it into an equity fund.
This strategy works if the equity market is volatile, with little visibility on whether they are going to trend upwards.
On the other hand, if the investor is heavily invested in equities and does not want to risk a sudden fall in prices, he/she can book profits by moving the amounts from an equity fund to, say, a lower-risk debt fund using an STP.
This has its benefits — the investor avoids the risk of timing the equity market and at the same time, the corpus earns market returns in the debt fund during the transfer period. It is, therefore, a flexible approach which reduces risk, and can help in optimal asset allocation, with good risk-adjusted returns.
Now, while this seems like a win-win for any investor, one needs to be cognizant of a few important points. First of all, an STP, like an SIP, is a strategy for mitigation of risk. As such, it protects you from losses, but to an extent. While it can alleviate the loss, it can also reduce the overall returns when markets are bullish.
The next point to remember is, as an investor, you need to follow the plan in a discipline manner because an STP's benefits accrue only when you follow the plan properly. Breaking the STP because of short-term market or interest rate movements can harm your investment in the long term.
The third point to keep in mind is, as an investor, you need to understand the underlying assets the funds are investing in and the stage of the market cycle. For example, it would be unwise to transfer money from debt to equity when the market is close to a peak value.
Similarly, it would be counterproductive to transfer money from equity to debt when the market is close to its bottom. Finally, as an investor with an STP, you need to consider and check thoroughly the taxation aspects of such a plan, which entails redemption out of the source scheme.
In the final analysis, it's an interesting and beneficial option if done well. So you could reach out to your investment adviser and inquire about this innovative route for investing.
Happy Investing!!
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