Volatile markets are a way of life for the Indian investor. Often that can deter mutual fund (MF) investors seeking growth. But that need not be so, if you have the right approach.

Take the case of Chanchal Das, a 45-year-old HR consultant from Delhi. Eight months ago, when he decided to invest Rs 1 lakh (Rs 100,000), he made sure that market volatility doesn't significantly impede the growth of his investment. He took recourse to a lesser-known, but highly effective approach of a systematic transfer plan (STP).

What is an STP? Through an STP, the investor can transfer parts of a lump sum from one MF scheme to another, within the same fund house, at regular intervals. Such a transfer averages the cost of purchase and thus mitigates market-related risks. The investor can first park his funds in a liquid or floating rate debt fund, and then get it transferred to the scheme (usually equity or balanced) of his choice at regular intervals.

Who needs an STP?

STP works well for investors who have a large sum of money to invest in equity markets, but do not have the skill or information to judge market movements and time their entry into the market.

Why should you invest through an STP?

"STP allows averaging of the cost even as your money earns more returns while in the waiting mode," says financial planner Gaurav Mashruwala.

Periodic transfer of money to an equity fund would mean that the investor gets more units when the markets are down and the net asset value (NAV) is low, and fewer units when markets are high. Therefore, the STP route will help the investor average the cost of acquisition of units. Thus, in effect, an STP follows the same approach as an systematic investment plan (SIP), which many of us are more familiar with, giving the benefit of cost averaging.

The major difference between the two being that STP works better for lump sum investments. Of course, STP hands you another advantage. The money parked in liquid or floating rate funds earn a higher return, currently as much as 6-7 per cent per annum.

This is much higher than the 3.5 per cent per cent per annum that you would get from a savings account if you were to wait for the market to calm down. Last, but not the least, STPs provide the flexibility of reviewing the amount to be transferred and the intervals at which the transfer takes place.

Where should the funds be parked and where should it be transferred?

Generally, investors choose to park their money in a liquid or floating fund as the NAVs of these do not fluctuate much. Opt for the dividend reinvestment option in liquid funds. Even though dividend distribution tax has been raised to 28.32 per cent, up from 14.03 per cent, it still works out better for those in the 30 per cent tax slab. Stick to the growth option if you are in the 10 or 20 per cent tax bracket.

The investor needs to check the minimum investment size of a MF before deciding on a parking slot. Some MFs like HSBC and HDFC require a minimum investment of Rs 1 lakh in liquid funds. However, the minimum investment size for Sundaram, SBI, Reliance and Prudential ICICI is Rs 5,000 for any type of fund.

However, even before you determine the parking slot, or the liquid or floating rate fund, you need to zero down on the ultimate destination of the funds: the equity fund. This is important since this will determine the fund house you will choose for both the schemes.

Of course, fund houses also offer STP combinations involving lower risk options such as balanced funds. The equity fund you choose for the STP could already be part of your portfolio or could be one that you are seeking to invest in. This means you can have combinations such as Sundaram Floating Rate Fund-Sundaram Select Midcap/Sundaram Capex Opportunities and SBI Magnum Cash Fund-SBI Magnum Contra Fund/SBI Magnum Global Fund .

Utility to the fore

STP's utility comes to the fore especially in volatile market conditions such as those today. They would have worked well in the past too but unfortunately, they didn't exist then. If we assume that a person invested Rs 1 lakh per month in index funds from January to December 1993, a period when markets were volatile, he would have seen a growth of 39.70 per cent in his investments.

The Sensex, on the other hand, gained only about 36 per cent in that period. But, the STP does not work as well in a market steadily going up. The return on STPs (index funds) was 24 per cent between January and December 2006 (when the markets went up steadily except for a couple of months in between) as against the Sensex growth of 48 per cent. The periodicity of the transfer is an important determinant, too. A monthly transfer imparts greater cost averaging benefits compared to a quarterly transfer since it captures greater market movements.

Other positives

As of now, not many people take the STP route. Rajiv Kumar, head, regional distribution (Delhi and Rajasthan), Karvy Stock Broking, says: "At present, only 3-5 per cent of investors opt for STP. It will take time for people to understand the product. The numbers will increase gradually."

However, STP is not a magic mantra for generating returns. It is just a way for disciplined investing over the long-term.