If you are retired and want to invest a portion of your retirement corpus in an instrument that offers regular income, you may choose a bank’s monthly income scheme (MIS). It offers guaranteed returns and works like a regular fixed deposit (FD).
The rate of interest on the MIS is similar to those offered on FDs. The interest is paid to you at regular intervals guaranteeing periodic income.
Another option that you may choose is fixed income plans offered by mutual funds. These types of mutual fund schemes invest in equities as well as debt products. Asset management companies (AMCs) invest between 10% and 25% in the stock market. The balance is invested in debt instruments such as government securities and corporate bonds.
Working of Monthly Income Plans (MIPs)
MIPs are managed in a manner where the investments in fixed-income securities aim to deliver steady returns for investors. These monthly plans offer regular income through monthly, quarterly, or half-yearly dividends. Originally, these plans were aimed to provide monthly dividends but the Securities and Exchange Board of India (SEBI) prohibits AMCs from giving return guarantee to investors.
Risk-return
The returns on monthly income plans may be volatile because a certain portion of the fund corpus is invested in equities. It is possible that the scheme may suffer a loss in case the stock prices see a huge downtrend. Therefore, the dividend payouts may be irregular not only in the amount but also in the frequency of such payouts. In certain instances, the schemes may not pay any dividends.
Here are two reasons why the returns differ from one fund to another.
- Asset allocation
The asset allocation varies from one plan to another, which means the returns offered by one monthly plan may differ from those delivered by another scheme. Depending on the fund manager, the average maturity on the debt instruments within the portfolio may be higher, which affects the returns.
Generally, a scheme that has a higher average maturity is riskier than one with a lower maturity. However, it also depends on the future movement of the interest rates. If the fund manager predicts accurately, higher average maturity is beneficial in providing greater returns.
- Equity exposure
The equity exposure taken by one fund manager may differ from another. As a result, the returns on different MIPs are not the same. Firstly, the fund manager determines how much equity exposure may be assumed. The next step is to identify the stocks where the fund corpus will be invested. The money may be invested in large, mid, or small-cap companies. A scheme with higher exposure to mid or small-cap companies is riskier than a fund that invests in large-cap stocks. Fund managers try to mitigate the risks by assuming exposure in multiple stocks with varying market capitalization.
Systematic Withdrawal Plans (SWPs)
If you do not want to assume the risk-return volatility, you may choose a Systematic Withdrawal Plan (SWP). This allows you to redeem a certain amount giving you a regular source of income.
Dividend payouts when you invest in monthly income plans are at the discretion of the AMC and not guaranteed. In case, the stock markets are negative, the fund may not have any surplus to distribute as dividends.
An SWP is beneficial to combat this risk. Even if the scheme is not making profits, the pre-determined amount is withdrawn. However, the shortfall, if any, is taken out of your capital investment, which reduces your principal. An SWP is advantageous when you invest a large amount. A smaller principal investment has the risk of faster capital erosion. If you choose the dividend option, your principal remains intact. Only the dividends are withdrawn and depend on the capital appreciation.
Tax implications
Monthly plans invest less than 65% of the corpus in equities and are considered as debt funds. AMCs deduct a Dividend Distribution Tax (DDT) before distributing the profits to you. Long-term capital gains taxes are 20% after indexation or 10% without indexation. Short-term capital gains, when you invest in monthly income plans, are included in your income and taxed according to your slab.
You may choose among several monthly plans. Making the right choice is not easy and requires research and analysis. To make this simpler, you may use ARQ, the smart investment engine from Angel Wealth. It uses advanced scientific methods to evaluate and analyze schemes based on a billion data points.
As a key highlight of Angel Wealth’s mobile application, ARQ provides customized investment recommendations that suit your risk profile and financial goals. The entire procedure is automated ensuring there is no human bias. Download the Angel Wealth mobile app and invest in monthly income plans to generate regular income for your retirement safety.