Friday, 17 June 2016

What are Monthly Income Plans in Mutual Funds

Raghav Chakroborthy, new General Manager of a private IT firm, started shooting his doubts to his best friend Madhav, when he wanted to save a part of his income for his two little angels.

“Oh yes of course Raghav!! Now that you have understood how to select mutual fund for your portfolio, I will tell you different schemes in it. You can get your income monthly by getting to Monthly Income Plans (MIP) of Mutual funds.

Monthly Income Plan (MIPs)

See…. In a mutual fund scheme, basically the amount is paid in accordance with the fund objective set by the mutual fund house. As you know, the amount that they distribute is in the form of dividends depends on the profit they make.
These MIPs are generally ‘Debt oriented schemes’. They invest the money in a mixed format- in both equity and debt. They normally keep a ratio of 20:80 or 30:70 or so. Their aim is to give the maximum regular benefits to the investor by reducing the risks.
Being said so, the major part of the fund will be invested in (70 to 100%) Debt instruments like ‘commercial paper, certificate of deposits, government securities, treasury bills etc., so that they can yield interest on them. The remaining will be invested in Equity.
This because the former will give stable, safe and consistent income, while the equity will keep on fluctuating in accordance with the portfolio management.
Now see, even MIP can be done in two ways: MIP Aggressive & MIP Conservative Plans. It depends on the percentage of equity exposure that MIPs take.
The one’s in which the investment in equity max 20% - 30% can be treated as “MIP Aggressive Plans” and the in which investment in equity is between 0-20% are treated as MIP Conservative. MIP Agressive may offer you  better returns on your investment. But yes!! Faster the returns, higher is the risks.”
“So is there any point of risk?” Raghav was taken aback.
“Yes… But if you keep a close eye on a few things it would be easy” Madhav consoled
“What are they?”
“Mmmm… for example:
Normally an MIP is affected by the interest rates. There is an inverse relationship  between interest rate and MIP. When interest rates goes downwards MIP provide better returns and vice-e-versa 
  • You have a variety of payout options- monthly, quarterly, half-yearly.
  • But they may charge an ‘Exit Load’, of around 1%, if you take it in less than one year of holding.
  • I believe that the ideal time for returns in MIPs can be around 3 to 4 years.”
“So it's not necessary that we get a regular income??” Raghav sounded curious.
“Well it not like that… You have two options in MIP say:

Dividend  Option : Dividends  in  MIPs  are  tax  free  in  hands  of  investors but Mutual  Fund companies  have  to  pay  a 28.33% Dividend  Distribution  Tax  (DDT)  including surcharge and cess and  30%  plus  surcharge  and  cess  for  others  (33.99%)  before distributing it to you as investors

Growth Option: If you opt for Growth option, it is subject to Capital Gains Tax. Short Term Capital Gains (if units are held for 36 months or less)  are taxed as per the Income Tax Slab Rate of investors. For Long Term Capital Gains (if units are held for more than 36 months) are taxed at 10% without indexation or 20% with indexation. The indexation benefit inflates the cost of purchase lowering long term gains tax liability, which is not the case of FD.

The tenure of the holding period matters, when one has to decide between growth and dividend options. You can go for the growth option if the holding period is more than a 3 years and for the dividend option if the holding period is less than 1 year

The reason is that gains from investment in Mutual Funds, if redeemed after 3 year in debt schemes, are considered
long-term capital gains. In the case of long-term capital gain, the investor is given the option of choosing between

  • 20% tax rate with indexation benefit, and 
  • 10% tax rate without the benefit of indexation
Long- and short-term capital loss- The good part of MIP is that any short term capital gains made on MIPs can be set off against short term losses. And long term gain on MIPs can be set off against long term losses.

Check an example of Indexation benefit here

Advantage of MIPs
Some of the features of balanced funds are:

1. Provides diversification in its truest sense by investing in bonds and equities
2. Invests a sizable proportion in equities, hence the returns you receive are decent
3. Provides automatic portfolio re-balancing; an added cushion during volatile markets. Therefore, when markets are positive, the fund manager sells equity to maintain its maximum level and vice versa
Investors should bear in mind that MIPs are also subject to market risks as both invest in equities. Neither scheme can guarantee income or returns and one should opt for a fund in line with their risk profile and investment objectives.

The drawback is that MIPs do not guarantee returns. But this is not a big worry as the better performing MIPs have regularly paid dividends. Therefore, for those who want regular incomes, like senior citizens or people with lower incomes, conventional products are better as returns are guaranteed.

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