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Getting the most out of Mutual Fund Monthly Income Plans

March 3rd, 2007

Last week, an investor came to me for advice on how he can get the best returns without taking high risk. He has some surplus funds received from his business and would like to go for investment in equities or mutual funds. This is a case with most of us – salaried employees getting a festival bonus or or surprise business profits on which you lost hope earlier.

One thing for sure is that ‘returns’ and ‘risks’ are co-related and returns largely depends on the risk taking ability of the individual. The more risk taking ability one has, the more chances that the money invested could be employed to get the returns.

Considering his age of 40+, I would not definitely suggest him to invest in equities, either directly or indirectly, not even in equity oriented mutual funds, or at least not to the maximum extent. And since he is already in the higher income bracket of taxation, investing in a bank fixed deposit or a NSS Certificate would not be wise considering the fact that returns on such investments are fixed and taxable, though the investment is safe and returns are assured.

Looking at the huge volatility in the markets for the last two months or so, we are sure no one would be getting an easy sleep these days. So here is a big ‘no’ to high risk investments, at least for some time now. With this in mind, we need to scale down our horizon to a somewhat lower expectation – moderate risk and moderate returns. But how can one go about this? I am sure many investors who do not want to take higher risks but would like to stay invested and see their money grow inch by inch will be in this type of situations.

What are Monthly Income Plans?

Before eying on the returns part of the plan we suggested to him, let us first examine how exactly Monthly Income Plans works. MIP Schemes are similar to any other mutual fund schemes except that the investments in these schemes are more debt oriented than equity oriented and the fund mangers  distribute profits (though not assured) by way of dividends at fixed periods of time. This way, investors can opt to get dividends at fixed intervals of time – monthly, quarterly or half-yearly.

The investments in MIP schemes are spread across various asset types including Corporate Debts, Government Bonds, Securitised Debt, PSU/PFI Bonds of banks, units of other mutual funds and a small portion of them into equities. In most cases, all these asset classes give fixed assured returns which are generally at the low side. The equity component is used for capital appreciation on a long term basis. Since the investment is more into debt-class, the capital is reasonable safer (though at times of huge volatility, the equity component causes a bit of damage).

Investment Amount

Your choice of fund/scheme largely depends on your investment amount for the MIP scheme. Some funds have MIP schemes that have a minimum application amount as low as Rs. 5000 while others require you to invest a minimum of Rs. 40,000 to give monthly dividends.

Returns and taxation

Like in any other mutual fund scheme, do not look for short term returns or capital appreciation for your investment in MIP. The idea of investing in MIP is to get maximum monthly returns, month after month and capital appreciation is only a secondary objective. Hence do a bit of study of MIP schemes and pick the best. Most MIP Scheme returns range from 5 – 12% for a 1-year period. Remember that returns in the form of dividends are tax-free and even at this low return-rate, they are far more better than fixed deposits, particularly if you are in the upper income tax bracket.

Maximizing returns

It is true that 5 – 12% returns is not so great from an investment perspective considering the fact that other mutual fund schemes have give over 20-30% returns, no matter how poorly they perform (Technology sector-specific funds have given over 50% returns during the last 1-year period). However, since we are more conservative and not aggressive in nature, we would like to use the monthly returns as the weapon for getting higher returns.

Let us take a hypothetical example so you can understand what we wish to tell in a better manner. Assume you have Rs. 1 Lakh surplus funds that you can happily set aside for investment by way of mutual funds in a conservative mode. You can invest this money into three MIP Schemes, such as, for example, Rs. 40,000 in HDFC MF Monthly Income Plan-Long Term Plan-Monthly Dividend Option, another Rs. 40,000 in FT India Monthly Income Plan-Monthly Dividend and Rs. 20,000 in DSP Merrill Lynch Savings Plus Fund - Aggressive-Monthly Dividend. This way we are spreading the money into three MIP schemes of three fund houses rather than risking by putting all the money into one fund house.

Since the money is invested into monthly dividend payout plans of the schemes, you will receive dividends at the end of the month. Assume that dividends received from the three funds at the end of the first month are Rs. 240, Rs. 270 and Rs. 150 which sums up to Rs. 660. This money will become available in your bank account at the end of the month (or maximum in the first week of the month).

Now, you can use this Rs. 660 dividend to invest in a mutual fund scheme that has a considerable larger equity portion through SIP for a period of 1 year. You can, for instance, begin with a SIP investment of Rs. 500 in a scheme such as Reliance Growth Fund or Reliance Vision Fund. Reliance Growth Fund has given over 30% returns in the past 1 year. Since you invest through the SIP route, rupee cost averaging comes into picture and you can still enjoy the feeling of investing regularly in a disciplined manner getting better returns irrespective of how the markets are performing. At the end of the year, your main MIP investment will remain safe giving decent returns while your equity oriented investment would have accumulated an investment of Rs. 6000 (Rs. 500 x 12 = Rs. 6000) which would hopefully give good return.

One problem here would be choosing a good equity oriented scheme that has the lowest first application amount and minimum SIP amount. Most ELSS come this way but ELSS funds are locked for 3-years. You can choose some specific schemes from Reliance Mutual Fund that accept Rs. 500 as minimum first application amount and SIP amount.

Remember that you are always retaining a small portion of the dividend received from MIP schemes after the SIP amount is deducted every month . In this example, the money will be Rs. 660 – Rs. 500 = Rs. 160. This money will come handy and will be useful in situations when the MIP itself is not able to give you a minimum of Rs. 500 as dividend. This is important because SIP is a monthly compulsory obligation you have committed to invest. This way you need not put in any additional money from your pocket to meet the SIP requirements.

If your bank account has accumulated a decent dividend surplus after the SIP allocation, say over Rs. 500, you can do one of these two: 1. Investment the money into the the equity fund as an additional purchase or 2. Invest back into one of the three MIP schemes chosen that has better dividend payout performance. You can do this exercise once in a quarter or so to ensure these surplus funds too are put for better use. You can review your entire portfolio once a year and do necessary adjustments such as moving to a different equity scheme or making adjustments to the MIP scheme investment.

Liquidity

MIP schemes have low entry load and exit load compared to equity funds. Most have 1% entry load and no exit load. FT India Monthly Income Plan-Monthly Dividend, for instance, has no entry and exit loads (for Plan A where minimum investment is Rs. 40,000) which means that you do not loose much money by way of load structures when you redeem units from your MIP investment. Hence these investments are reasonably good at liquidity and would come handy when you need to pull funds from your investments.

This way, investments in a combination of MIP and Equities can be used to get reasonably good returns by taking moderate risk. As with any other investments, this plan too suffers from market risks. We made a good number of assumptions (such as expecting that dividends from MIP scheme investments are always over the committed SIP amount etc.) that will impact the performance of mutual funds. Hence use your good judgment in implementing an investment plan such as this.

Entry Filed under: Mutual Funds