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You might have come across the term “systematic transfer plan” if you read about investment advice and expert opinions on mutual funds. A systematic transfer plan (STP) is often recommended to investors who want to deploy a big amount in equity mutual funds for long-term growth.

It doesn’t need to be repeated that you shouldn’t invest a lump sum amount in an equity mutual fund. The best way to invest in equity mutual funds is through a systematic investment plan (SIP). An SIP insulates you from catching a market peak and allows you to benefit from rupee cost averaging. For long-term wealth building from equity funds, spreading your investments over time is a much better option than investing a big amount in one go.

systematic transfer plan

But what do you do if you have a big amount to invest? Let’s suppose you sold a capital asset like a house and you have around ₹5 lakh in your bank account. You are not going to use this money to buy another house and it obviously doesn’t make sense to let it lie around in the bank either. So, you have decided to invest this money in equity mutual funds to allow yourself to earn higher, tax-efficient returns. Good decision. The idea is right, but the execution would be wrong if you invest the entire amount in one go in an equity fund.

How does an STP work?

The correct execution would be the systematic transfer plan (STP) route. An STP is a periodic transfer from one mutual fund to another. Typically, an STP is a transfer from a debt mutual fund to an equity mutual fund. An STP can be done when both mutual funds are from the same fund house. For the above example, here is how an STP would work:

  • You invest the entire amount of ₹5 lakh in a debt mutual fund like a short-term debt fund or a liquid fund
  • These funds would give higher returns than a bank account, even after taking taxation into consideration
  • Then, you give the fund company a mandate to deduct a particular amount every month, say ₹25,000, from the debt fund and invest it in an equity fund
  • This way, you are able to invest systematically in an equity fund
  • The money that stays in the debt fund waiting to be transferred earns higher returns than it would in a bank account

This is how a systematic transfer plan works. It allows you to invest systematically and earn decent returns on the money that would lie idle in your bank account. An STP can also be used to rebalance your portfolio from equity to debt. The STP amount is usually a fixed one, but you can also have a flexi STP where a variable amount is added to the fixed amount when the transfer is made. In the flexi STP, this variable amount depends on the performance of the first mutual fund as a certain percentage of the fund’s gains are also added to the STP amount. A fixed STP is easy and uncomplicated and works best for most investors.

Taxation on systematic transfer plans

While an STP is a good strategy, you should be aware of the tax implications on the transfer. Every transfer from one fund to another is considered as a redemption and fresh investment. This redemption will usually be taxable. So, the amount that gets transferred from a debt fund will be a redemption and will be subject to short-term or long-term capital gains tax, depending on the holding period. But even with this tax aspect, the returns earned would be higher than those in a bank account.

This is how a systematic transfer plan would be a good strategy to invest in equity mutual funds without catching a market peak and losing out on interest income.

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