Ask Morningstar: Doing an STP from a debt to equity fund

By Mohasin Athanikar |  22-04-22 | 
 
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Mohasin Athanikar is an Investment Analyst for Morningstar Investment Adviser India.

I have a question about STP.

Why do advisers suggest that one must not invest a lumpsum in the stock market but instead, put the money in a debt fund and do an STP from debt to equity?

What are the tax repercussions of an STP? If there is a tax issue, is it not more convenient just putting money in savings account and transferring it to equity via an SIP?

A systematic transfer plan (STP) allows investors to periodically transfer (switch) a fixed number of units from one mutual fund scheme to another. To use your example, an STP from a debt scheme to an equity scheme. This is an automated process.

Valuations play a crucial role while entering any asset class /security. Lower (cheaper) valuations reduce the risk of high future capital loss and improve upside potential, and vice-versa.

Volatile asset classes (equity, gold) witness sharp cycles with both strong up-move phases and down-move phases. Given their cyclical nature and high volatility, it is advisable to invest in a staggered manner, via the SIP/STP route.

Investing a lumpsum amount in the stock market may result in the entire principal invested being subject to the risk of sharp drawdown in a falling market. Investing via SIP/STP will split the investable corpus across the ups and downs of the market. This will benefit the investor cause when the market falls, she will get more units.

Why the corpus should be initially parked in a debt fund and not savings account.

Parking money into less volatile debt funds such as overnight/liquid/ultra-short-term funds is typically advised, since the corpus is accruing interest till the time it is invested into the target equity fund.

Prior to the sharp rate cuts by the RBI since 2019 and surplus liquidity in the banking system which led to a sharp decline in money market interest rates, these funds (typically invested into money market instruments) earned higher interest then savings bank deposits.

Also, an STP inculcates disciplined investing into equities, since money from their savings bank account could be spent and investors would then miss out on regular investing.

Taxation.

Transfers via the STP route are essentially treated as redemptions from the source fund, in this case your debt fund. Hence, the money you redeem is subject to capital gains tax (short-term or long-term) depending on the holding period and asset-class orientation of the scheme invested in (equity/fixed-income / commodities).

For debt funds, capital gains in case of holding periods up to 3 years are termed as short-term gains and taxed at the marginal rate of income. Capital gains in case of holding periods more than 3 years are termed as long-term gains and taxed at 20% with indexation.

Registered readers can post their queries by accessing the Ask Morningstar tab. Our team will answer SELECT queries relating to mutual funds, portfolio planning and personal finance. While we provide broad guidelines, we suggest you consult a financial adviser before making investment decisions.

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Articles authored by MOHASIN ATHANIKAR

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