Lumpsum vs STP: what is a better investment strategy?

When it comes to investing, not only are there many avenues available, but also many ways to invest. Common modes of investment include lumpsum, Systematic Investment Plan (SIP) and Systematic Transfer Plan (STP). Knowing each of these can help you choose the strategy that would be most suited for your needs.

In this article, we look at the difference between lumpsum and STP to guide you on the investment mode that could be suitable for you.

• Table of contents

1. Understanding lumpsum
2. Understanding STP
3. Differences between lumpsum and STP
4. Factors to consider when choosing STP and lumpsum

Understanding lumpsum

Lumpsum investment involves putting in a large amount of money in one go. One advantage of lumpsum is that your money starts working for you immediately.

Lumpsum investing harnesses the power of compounding to its fullest potential. This is because potential returns are generated on the entire principal amount right from the beginning. These returns, when reinvested, have the potential to earn further returns, which leads to a compounding effect, as and when the market goes up. Over time, compounding can lead your investments to grow at an accelerated rate and exponentially. You can make use of a compound interest calculator to get an idea of compounding can help your wealth grow over time.

This means that when the market is performing well, your return potential is optimized. However, if the market goes down, you can also face significant losses.

Thus, lumpsum investing may be suitable for those who have a large amount to invest and can handle market fluctuations.

Understanding STP

STP stands for Systematic Transfer Plan. It involves transferring funds systematically from one mutual fund scheme to another within the same asset management company (AMC). These transfers can occur at predefined intervals, typically monthly or quarterly.

The main idea behind STP is to park money in a debt fund or liquid fund initially and then transfer it into an equity fund over time.

This systematic approach can help investors to tap into the potential growth of equity markets while reducing the exposure to market volatility through rupee cost averaging. By investing a fixed amount regardless of market conditions, you end up purchasing more mutual fund units when the Net Asset Value is low, and fewer when it is high. Over time this strategy typically reduces your per-unit cost, thereby enhancing return potential.

STP is therefore useful for investors who want to manage market volatility and mitigate risk by gradually transferring their investments from a less risky asset (such as a debt fund) to a riskier one (such as equities). It is also useful for investors who want to diversify their investments over time. Some investors also choose to transfer only the gains from their debt investments into equity, while leaving their initial capital in a relatively low-risk avenue.

Differences between lumpsum and STP

While both lumpsum and STP allow you to invest and potentially grow your wealth, there are key differences between the two approaches.

Market timing - With lumpsum, your entire invested amount is exposed to current market conditions immediately. STP spreads your investment over time, averaging out market ups and downs through rupee cost averaging.

Volatility - A lumpsum investment bears the brunt of market volatility impacting the overall return potential. STP cushions against volatility by systematic rupee cost averaging and averaging out the cost of investment over time.

Asset allocation - Lumpsum allows immediate and full allocation to the target asset class like equity. STP starts with debt allocation, then switches to equity over time.

Liquidity - Full lumpsum amount gets locked in the investment. STP keeps part liquid in debt funds.

Flexibility - Lumpsum investments are less flexible. STP allows adjusting transfer amounts based on market conditions.

Investment discipline - Lumpsum needs discipline to stay invested in downturns. STP enforces discipline by virtue of being periodic and systematic.

Ideal market scenario - Lumpsum may lead to a relatively better return potential if invested at market lows. STP works well in moderately volatile sideways markets.

Wealth creation - Lumpsum can optimise wealth creation through full compounding. STP may limit upside in bull runs due to partial equity exposure.

Factors to consider when choosing STP and lumpsum

When choosing between lumpsum and STP, consider the following factors:

• Market conditions: If the market is low, a lumpsum investment can be beneficial as you can buy more units at a lower price. However, if the market is uncertain, STP can help manage risks.
• Risk tolerance: If you can handle high risks, lumpsum might be suitable. But if you prefer to minimize risks, STP is a better option.
• Financial goals: Your financial goals also determine the most suitable or preferred strategy.

Conclusion

STP involves gradual investment, reducing risk, while lumpsum is a one-time investment, suitable for high-risk tolerance. STP averages out market fluctuations, whereas lumpsum has the potential to capture market gains immediately and fully benefit from the power of compounding on potential returns. The choice between them depends on your risk tolerance, market conditions, and financial goals. It is always recommended that you consult a financial advisor before making major investment decisions. You can also use an STP calculator and a lumpsum calculator to assess the difference in the growth potential of an STP and lumpsum investment.

FAQs

What is the minimum investment requirement for lumpsum and STP?

The minimum investment for lumpsum or STP varies based on the fund but starts at around Rs. 500 in several schemes.

How do lumpsum and STP differ in terms of risk management?

Lumpsum carries higher risk as it involves investing a large amount at once, subject to market fluctuations. STP reduces risk by spreading investments over time, averaging out market volatility. Moreover, STP investments enable investors to leave a portion of their funds in a relatively low-risk avenue such as debt mutual funds.

Can I switch between lumpsum and STP easily?

You can start an STP in a scheme that you had earlier made a lumpsum investment in. This may involve a quick and easy application process.

Are there any tax implications associated with lumpsum and STP?

The tax implications depend on the mutual fund scheme category, the holding period and the amount redeemed. This would be applicable to both lumpsum and STP. Mutual fund returns are subject to capital gains tax. For equity schemes, a short-term capital gains tax of 15% is levied for holdings of less than a year and a 10% long-term capital gains tax for holdings of a year and above. For debt mutual funds, the gains are added to the investor’s total income and the taxed as per the tax slab

What types of assets can I invest in using lumpsum and STP?

You can invest in various assets like mutual funds, stocks, bonds, and other financial instruments using both lumpsum and STP. The choice of assets depends on your financial goals and risk tolerance.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.