Creating Systematic Transfer Plan

I have few FMPs maturing over next few months. After the introduction of direct plans I am also redeeming my funds as and when they turn long term investments to invest in corresponding direct plans. I have few debt funds which I want to invest in equity plans as part of portfolio balancing. Due to this, I am going to have steady flow of big amounts which needs to be put in a STP plan with a duration of 12 months. So I was making a plan, and here is the process I followed.

Choosing transferer scheme

There are 3 options. 

Using FDs. The amount can be invested in any FD scheme. They are very tax-inefficient and the process can become cumbersome to implement.

Leaving in the savings account. The interest rate is very low compared to all the options. They are also not tax efficient. Even though there is a deduction of Rs.10000 for savings bank interest, the money I keep in banks for liquidity purposes (3,4 months of salary) already earn that much interest.

This leaves the only option of debt mutual funds.

The following decisions need to be taken for choosing the funds.

• Dividend schemes or Growth schemes:

Growth schemes attract capital gains tax and as we are implementing an STP, almost all of those gains will be short term capital gains. So the gains will be added to the income and and taxed as such. So for any body who will fall in 20% and 30% slabs, taking the gains as dividend makes sense as some schemes offer 13.52% as . For others, the growth options will make more sense.

• Liquid funds or Ultra short term funds or other funds       

Liquid funds are the least risky of the mutual funds. They are introduced for parking the money that needs to be deployed in the near future. Only disadvantage is they are tax inefficient. the Dividend Distribution Tax  is 27.04% almost same as the normal tax I pay and for anybody in the lower slabs, they actually will be paying more tax. For other debt funds, the DDT is 13.52% and this is the least the tax law allows as of now. But for many funds, there will be exit loads and are slightly riskier (even though rate cuts are expected in the near future). Only the Ultra Short term funds come with zero exit loads (some not all) and almost the same risk profile as liquid funds. So my decision is to invest in UST debt funds.                                                                                         

• Dividend frequency 

Here the options are daily dividend and monthly dividend. Other option to consider is dividend reinvestment or taking the dividend. Dividend reinvestment on a daily dividend scheme will make your investments very complicated. You will have almost 250+ entries for an year of investment and to compute gains and losses on that will be very complicated. On the top of that if there are losses, you need to compute how much of the loss comes under dividend stripping. Monthly dividend option is simple but depending on the dates of dividend deposit and the STP dates, you may have some gains and losses. fortunately the daily dividend schemes keep the NAV constant. They announce the dividend such that every days gains exactly take care of dividend and dividend distribution tax. So intuitively I thought a daily dividend scheme with dividend reinvestment is the easiest option to manage account for tax purposes as well as maximum benefit of growth ( the reinvestment makes sure that the gains are always participating in the scheme for gains.

Now the question is how less dividend reinvestment on daily basis earn compared to monthly dividend reinvestment as in the later case the tax is paid only after one month. That is another post showing the calculations but it is suffice to say that not much will be lost.

Now choosing the actual funds. I invest in ICICI discovery, HDFC prudence and equity and Reliance regular savings fund - balanced option. So I need to choose three funds from these fund houses. They need to be ultra short term funds and need to have daily dividend option and no exit loads. After going through value research online these are funds I chose.

1. ICICI prudential flexible Income
2. hdfc cash management fund treasury advantage plan
3. Reliance Money Manager