Want to invest a large sum in mutual funds? Use systematic transfer plan instead of SIP
ET CONTRIBUTORS|
Oct 16, 2017, 10.36 PM IST
By Dhirendra Kumar
Anyone who has even the tiniest interest in mutual fund investing knows of SIPs, which is the best way to invest in mutual funds. SIPs work by setting up a regular, fixed investment every month. There are many advantages of this. From a returns perspective, it gets you a buying price that is averaged over many months or years, which eventually enhances returns. Any episode of falling stock prices actually benefits the investor because your SIP ends up buying more units for the same amount of money. Most importantly, the monthly instalment fits the income pattern that most people have.
However, there are plenty of times when one needs to invest money that has come in a lump sum and does not fit the monthly pattern. If it’s meant for the long-term and you’d like to invest in an equity fund, then the most natural thing to do is to invest it all in one go. That will also be the advice of anyone who is selling you the fund because that’s the way to generate a big commission immediately. However, that is the risky path. What if you invest and the markets tank 10-20% soon thereafter? You would lose a big chunk of your money. In all probability you would panic and redeem the entire sum.
The solution is simple, but relatively few investors are aware of the SIP’s close cousin, which effectively provides the same potential for higher returns and lower risk as SIPs do, but for onetime investments. This is the Systematic Transfer Plan, or the STP. An STP is a regular transfer of money from one fund to another. It’s like an SIP but the source of the money, instead of being your monthly income, is another mutual fund. So how does this make sense?
It makes sense because you initially invest the money in a debt fund, which are highly predictable and non-volatile. Here’s an example. Let’s say you have received Rs 10 lakh which you would like to invest in an equity fund. This could be a bonus from an employer, or an asset sales, or maybe a very lucky pre-Diwali night. If you invest the entire sum at one go, you are exposing the entire investment to any sudden decline in equity markets. Therefore, what you need to do is to choose your equity fund and then, choose a short-term debt fund from the same fund company. Invest the entire sum in the debt fund, and then instruct the fund company to transfer say, Rs 1 lakh into the chosen equity fund every month. In 11 or perhaps 12 instalments (not 10, because there will be returns), all your money would have shifted to the equity fund. Your buying price would be the average of that time period, thus insulating you from market fluctuations.
Of course, STPs, like SIPs, are not foolproof. If you actually look back at the markets over the last decade, you will realise that while an STP generally helps one avoid a market peak and average costs, they’re not a foolproof device. If the markets keep rising for many years, as they did from 2003 to 2008, and then fall sharply, then even an STP cannot eliminate losses. Equity is equity and there’s no way of doing away all risks. However, based on what has happened over the last two decades in India, stretching an investment over one to three years is likely to capture enough of a market cycle to significantly reduce risk.
How does one decide the period? That depends on how significant is the sum of money in your overall assets. If, for example, it’s the proceeds of a property sale on which some major future plan depends, then three or even four years is appropriate. On the other hand, if it’s a bonus worth a few months’ income, then maybe six months is enough. There’s no rule— it all depends on what you feel is the risk.
At the end of the day, the key question that an investor has to ask is the trade-off between the risk of short-term equity market gyrations and the long-term returns that one can generate from equity. And as for cycles that are long as well as extreme, like the one from 2003 to 2008, those are like a natural calamity. You can prepare for them, but there’s nothing that will keep you 100% safe.
The writer is founder and CEO of Value Research.
Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.
Anyone who has even the tiniest interest in mutual fund investing knows of SIPs, which is the best way to invest in mutual funds. SIPs work by setting up a regular, fixed investment every month. There are many advantages of this. From a returns perspective, it gets you a buying price that is averaged over many months or years, which eventually enhances returns. Any episode of falling stock prices actually benefits the investor because your SIP ends up buying more units for the same amount of money. Most importantly, the monthly instalment fits the income pattern that most people have.
However, there are plenty of times when one needs to invest money that has come in a lump sum and does not fit the monthly pattern. If it’s meant for the long-term and you’d like to invest in an equity fund, then the most natural thing to do is to invest it all in one go. That will also be the advice of anyone who is selling you the fund because that’s the way to generate a big commission immediately. However, that is the risky path. What if you invest and the markets tank 10-20% soon thereafter? You would lose a big chunk of your money. In all probability you would panic and redeem the entire sum.
The solution is simple, but relatively few investors are aware of the SIP’s close cousin, which effectively provides the same potential for higher returns and lower risk as SIPs do, but for onetime investments. This is the Systematic Transfer Plan, or the STP. An STP is a regular transfer of money from one fund to another. It’s like an SIP but the source of the money, instead of being your monthly income, is another mutual fund. So how does this make sense?
It makes sense because you initially invest the money in a debt fund, which are highly predictable and non-volatile. Here’s an example. Let’s say you have received Rs 10 lakh which you would like to invest in an equity fund. This could be a bonus from an employer, or an asset sales, or maybe a very lucky pre-Diwali night. If you invest the entire sum at one go, you are exposing the entire investment to any sudden decline in equity markets. Therefore, what you need to do is to choose your equity fund and then, choose a short-term debt fund from the same fund company. Invest the entire sum in the debt fund, and then instruct the fund company to transfer say, Rs 1 lakh into the chosen equity fund every month. In 11 or perhaps 12 instalments (not 10, because there will be returns), all your money would have shifted to the equity fund. Your buying price would be the average of that time period, thus insulating you from market fluctuations.
Of course, STPs, like SIPs, are not foolproof. If you actually look back at the markets over the last decade, you will realise that while an STP generally helps one avoid a market peak and average costs, they’re not a foolproof device. If the markets keep rising for many years, as they did from 2003 to 2008, and then fall sharply, then even an STP cannot eliminate losses. Equity is equity and there’s no way of doing away all risks. However, based on what has happened over the last two decades in India, stretching an investment over one to three years is likely to capture enough of a market cycle to significantly reduce risk.
How does one decide the period? That depends on how significant is the sum of money in your overall assets. If, for example, it’s the proceeds of a property sale on which some major future plan depends, then three or even four years is appropriate. On the other hand, if it’s a bonus worth a few months’ income, then maybe six months is enough. There’s no rule— it all depends on what you feel is the risk.
At the end of the day, the key question that an investor has to ask is the trade-off between the risk of short-term equity market gyrations and the long-term returns that one can generate from equity. And as for cycles that are long as well as extreme, like the one from 2003 to 2008, those are like a natural calamity. You can prepare for them, but there’s nothing that will keep you 100% safe.
The writer is founder and CEO of Value Research.
Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.
