I lost money through the systematic transfer plan (STP). I would have been better off had I invested a lump sum,” said a disgruntled Ayush, who had recently invested in an equity mutual fund via an STP.
An STP divides an investment amount into instalments over a specific period, typically varying from a month to a year. The money is initially held in a low-risk mutual fund such as a liquid or money market fund, and gradually transferred to a higher-risk equity fund at regular intervals. STPs can be fixed or flexible. A fixed STP transfers a set instalment over a specific time interval. A flexible STP transfers a variable instalment, typically depending on market conditions, with a higher amount transferred when markets are low and vice versa.
Ayush’s analysis showing lower gains through a systematic transfer plan (STP) compared to investing upfront was accurate for his specific investment period, though it may not hold true universally. In his case, Ayush invested ₹3 lakh in a liquid fund, which was systematically transferred in three equal monthly instalments into an equity mutual fund. The first instalment of ₹1 lakh was invested at an NAV of ₹40, fetching 2,500 units; the second went in at an NAV of ₹39, buying 2,564 units; and the third at an NAV of ₹42, purchasing 2,380 units. In total, he accumulated 7,444 units. At the current NAV of ₹43, these units were worth about ₹3.2 lakh. His average purchase cost worked out to ₹40.3 per unit, having bought 7,444 units for ₹3 lakh.
Instead, had Ayush invested ₹3 lakh upfront in the equity scheme at NAV ₹40, he would have gathered 7,500 units, the current value of which would have been ₹3.22 lakh. Hence, he incurred a ‘loss’ of ₹2,000 by adopting the STP strategy. The loss was the opportunity cost of spreading his investment rather than investing all at once.
Ayush gained less by investing via STP during a period when markets were generally on the upswing. However, had the markets corrected during the STP tenure, his gains would have been higher. For example, if the three instalments had been invested at NAVs of ₹39, ₹38, and ₹37, total units purchased would have been 7,897, higher than the units gathered earlier. At the current NAV of 43, the value of these units would have been approximately ₹3.4 lakh instead of ₹3.2 lakh. Ayush would have finished with ₹20,000 more in gains, since his average cost per unit would have been ₹38 instead of ₹40.3.
Also, in the above calculations, we are ignoring the returns the liquid fund yielded, which are added to the total return. Investing via STP benefits from rupee-cost averaging. We’ve often heard that rupee-cost averaging is a good strategy for investing over long time horizons. When we invest a fixed amount each month, we buy more units when prices are low and fewer when prices are high. Such a strategy limits the units you purchase when prices are high, lowering the average unit cost in the long run. When we invest our surplus each month through a systematic investment plan (SIP), rupee-cost averaging occurs automatically. When investing a lump sum, we have a deliberate choice to make between investing upfront or via an STP.
For most investors, the pain of losing money outweighs the joys of gains. The STP strategy is akin to buying an insurance policy to protect our investments from bad timing. If we had invested upfront and the market had corrected shortly thereafter, we would have missed out on lower NAVs. If the markets rose, we would have gained more by investing upfront than via STP. Since no one can predict markets in the short term, an STP strategy removes market-related timing by spreading the investment. The investor pays a small price by forgoing returns during a bull market, but avoids the regret of missing the opportunity to lower her average cost during a market correction.
A big benefit of an STP strategy is that it removes behavioural biases. By automating investments, STPs remove emotion from the investing process. An STP strategy is a risk management tool rather than a wealth-enhancement tool. STPs are not meant to create gains or losses; they are simply a method of investing. Gains or losses are determined by the performance of the target/equity fund.
An investor will benefit most from an STP strategy when markets are volatile, providing ample opportunities to buy when prices are low. The investing experience is a lot more stable and disciplined. In the long term, markets only go up, returns average out, and the STP strategy may deliver the same returns as investing upfront.
For long-term investors whose decisions are driven by logic rather than speculation, greed or fear, investing upfront is a superior option. For the rest of us, it’s wiser to adopt STP, so we stop trying to predict.
Priya Sunder is a director and co-founder at PeakAlpha Investments.
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