Did you know: the type of debt funds best suited to systematic transfer plans

If you have a lump sum to invest, it is best to put it in a debt fund and systematically move it to an equity fund. But all debt funds ar not the same. Find out which suit this purpose most

We couldn’t stress enough that one of the better ways to invest in equity mutual funds is through a systematic investment plan (SIP). But if you have a lump sum, there is a tool that is quite like an SIP. Called systematic transfer plan (STP), this is a facility that lets you invest your lump sum corpus in a debt fund and then transfer a fixed sum of money, at periodic intervals, to an equity fund. This ensures that while your money remains in a debt fund, it gives you slightly higher returns than what your savings bank account would have—had you deposited it there and then done an SIP. That’s the easy part. The question is: which debt fund to choose for an STP? Most fund houses, especially the large ones, have many debt funds. They start from the basic set of liquid and ultra short-term funds to short-term funds to long-term debt funds like bond funds and government securities (g-sec) funds. Technically, you could do STP from any of these funds to any equity fund of your choice. The only condition that mutual funds impose upon you is that both the outgoing fund (debt fund, in this case) and the incoming fund (equity fund) have to be from the same fund house. 

Low maturity fund...

Most financial planners recommend low maturity funds, like a liquid fund or an ultra short-term fund. These funds, typically, have underlying investments that mature between a month and 3 months. Even in the case of ultra short-term funds, many financial advisers suggest those that come with low duration, typically up to 3 months or so. The higher the duration, the more sensitive your debt fund is to interest rate movements. But you want to choose a debt fund that is better protected from volatility in interest rate movements. And low- to very-low-maturity debt funds don’t get impacted much by interest rate movements. Very-low-maturity funds, typically, also don’t have exit loads. This helps your cause, especially if you have chosen a daily or weekly STP option. In other words, if you have opted for money to be moved out from your debt fund to the equity fund every day or once a week. 

...or a higher maturity fund?

Some financial advisers say that when investors insist that they wish to transfer the money over a slightly stretched period of time, say, a year or two, then it could make sense to opt for an ultra short-term fund with higher average maturity or a short-term debt fund. A short-term debt fund is typically meant for investments with time horizon of a year or two. Hence, if your money is going to be parked for that long, some advisers suggest these funds. But keep in mind the interest rate risks. Since the maturities are longer, they are more exposed to interest rate movements. 

What you should do

We suggest you stick to very-low-duration funds, like liquid funds. Remember, when you do an STP the money that you put in a debt fund is only meant for parking purposes. The ultimate goal for that money is the equity fund where it aims to go. Hence, your debt fund shouldn’t be the place where you need to make money. It is a parking space where, in fact, you need to protect the capital as much as you can. And, in the process, hopefully earn a little more than in a savings bank account. So, stick to liquid funds or ultra short-term funds for STPs.