Fade-up with high volatility in share market? Looking for safe source to invest some money to earn steady monthly income? If yes, than while searching for the most appropriate investment avenue you must have come up with Monthly Income Plans of Mutual Funds as you answer. But before investing in Monthly Income Schemes of Mutual Funds, you should know the pitfalls and limitations of these plans.
What is Monthly Income Plans of Mutual Funds?
Monthly Income Plans offered by Mutual Fund Houses are nothing but a debt oriented mutual fund schemes which give you income in form of dividends. MIPs invest about 70% to 80% in debt instruments such as government securities, corporate bonds, money market instruments and debentures and remaining 20% to 30% in equities and cash. The income you get in form of dividends can be taken out in various intervals such as monthly, quarterly, half-yearly or yearly. Similar to every other mutual fund scheme MIPs too come in two variants.
- MIP with Dividend Option:
Under MIP Dividend Option you will be given an income in form dividend at regular interval, if any. You can choose the intervals in which you wish to receive dividend i.e. monthly, quarterly, half-yearly or yearly. Please note the dividend received by you is tax-free but AMC paying out the dividend is required to pay the DDT @ 15% with cess and surcharge also which eventually reduces your dividend in the first place.
- MIP with Growth Option:
Under MIP Growth Option no money is paid out you. The profits earned from the invested amount will keep growing and you will get accumulated amount with all the profits only at the time of redeeming the mutual fund units. The benefit you reap in growth option is higher than dividend option because the compounding works wonders for longer terms but your profits may get reduced due to taxation. (Discuss later in the article).
Pitfalls of Monthly Income Plans of Mutual Funds
You must have got the basic understanding of both the options of Monthly Income Plans of Mutual Funds. But there are few limitations or say myth which you should know before parking your money into MIPs. Below points are solely regarding Monthly Income Plans i.e. MIP with Dividend Option.
No Guaranteed Regular Income/Dividend
First of all, you cannot expect to get regular income aka dividend. Since MIPs invests in debt as well as equities, the certainty of profits are not sure. On top of it, regulation guiding Mutual Funds clearly states that dividend can only be paid only from the surplus/profits and not from the capital. For example, if the NAV of MIP increases from Rs.10 to Rs.13, than fund can declare dividends only out of the surplus of Rs.3. Hence, if the fund’s NAV decreases due to market swings or rate reductions, there may not be any dividends.
Track records of the existing 26 Monthly Income Plans also shows that for the last five year (since September 2010) only half of them were able to pay regular dividends. This means the chances of receiving regular dividends is just 50%. In short it can be said you cannot only rely on MIPs for your basic living expenses.
Not Zero Risk
As you have already read that MIP invests around 70% to 80% in debt instruments and remaining 30% in equities and cash, not only equity part offers volatile returns, debt part also exposed to volatility due to interest rate movements. For instance, if interest rates go up, the old bonds having bearing less coupon rate may become less attractive, results in reduction in their market price. Due to this MIP may show negative returns also.
Further, debt part of MIP also includes corporate bonds in its portfolio and in case these bonds makes default in payment of interest or capital, than there may be significant capital erosion in the fund.
Double Digit Return Figure
There are few misunderstanding/mis-selling happens in MIP. First one is due to lack of knowledge of investor and second one is due to high commission structure of agents.
Double digit return is the foremost lucrative point of buying MIPs. This is the only reason of picking MIP instead of Bank Fixed Deposits. But the returns of 10% to 20% as stated by the agents in recent times accrue to the growth option of MIPs not in dividend option. Since growth options bears the benefit of compounding with no withdrawals, the returns from Growth Options are far better than that under the same fund’s Dividend Option. Remember, under dividend option, NAV gets reduced to the extent of dividend paid. So if NAV of the fund before paying out dividend of Rs.3 was Rs.25 than post payment, the NAV would fall to Rs.22 per unit.
Apart from the above, due to high commission structure of the agents particularly in case of MIP (as much as 1-1.5% unlike 0.5-.75% in Equity funds), these MIPs are tagged as “Safe Funds” and “Income Guaranteed Funds” which we have seen not the case.
Another heart breaking point is that most of the MIPs have higher expense ratio (around 2% or more) than other debts funds which eats into the overall returns.
Taxation of Monthly Income Plans
MIPs are debt oriented mutual fund schemes and thus the tax treatment will be same as debt funds:
Short Term Capital Gains:
Redeeming MIPs units before 3 years (earlier 1 year) would be short term capital gains and attracts tax. The profits would be added to your income and taxed as per your slab rate.
Long Term Capital Gains:
In case the units of MIPs are sold after holding for 3 years, than the gains may be long term capital gains. The profits would suffer from flat tax rate of 20% (plus 3% cess) after indexation.
Short Term and Long term Capital Loss:
In case you have incurred short term or long term losses in MIP, you can set off it against capital gains in the same year or can carry forward in next 8 years to set off against future capital gains.
Tax on Dividends:
Dividends received by the investor are tax-free but company paying dividend is required to pay dividend distribution tax of 15% (plus cess and surcharge).
Read More on Tax Treatment of Equity and Debt Mutual Funds
MIP vs Fixed Deposits / POMIS
Investors with low risk-appetite i.e. retired or semi-retired persons or conservative investors can find Monthly Income Plans better than Bank FD but have to keep in mind that return of MIP is linked to market and thus exposed to volatility.