Tuesday, April 16, 2013

What are Monthly Income Plans?

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Monthly Income Plan popularly known as MIP is a debt oriented hybrid mutual fund product. In MIP Equity is allocated in between 5% -25%, and the balance would be the debt allocation. The Investment objective of Monthly Income plans read as , " To generate regular returns through investment primarily in Debt and Money Market Instruments , also to generate long-term capital appreciation by investing a portion of scheme's assets in equity and equity related instruments". Though the objective is to provide regular returns, but the regularity and quantum is not assured. Advisors/Planners do advise on MIP to supplement the goal of regular returns and also to provide some tax efficiency in client's profile. MIPs also get advised in growth option if client portfolio and risk profile demands.

 

What is Systematic Withdrawal Plan?

 

Systematic withdrawal plan also known as SWP is a facility that allows an investor to withdraw money from existing mutual fund investments at specified intervals. SWP facility is used to create a regular flow of income from investments. You can do a Fixed SWP where you specify the amount you wish to withdraw or Appreciation SWP where you can withdraw the appreciated amount every month or quarter.

 

How Systematic withdrawal is beneficial in Monthly Income Plans?

 

Now you have understood that to generate regular income (not assured) from MIPs, you can either opt for Dividend payout option, which are irregular and also not certain or you may go with MIP growth option and opt for SWP. In the former case you have to bear with the dividend distribution tax and in latter you withdraw units out of your capital and appreciation (if any). Question is which would be better option.

 

I did some back testing on a Monthly income plan of one popular AMC to figure out the answer.

 

Below are the details.

Investment amount : Rs 975000/-

Date of Investment : 1 Jan 2008

Date of redemption: 1 Jan 2013

Product and Units alloted :

Reliance MIP (Monthly dividend payout): Units allotted 85901.57 (@ NAV – 11.3502)

Reliance MIP Growth : Units allotted 64732.01 (@ NAV – 15.0621)

SWP rate : @ 8% p.a payable monthly

Dividend dates/rates : As per actual

The above calculation clearly shows that in the last 5 years, Systematic withdrawal plan @8% p.a payable monthly would have been a better option than Monthly dividend pay out . The reason might be the dividend distribution tax, and if actually that was the reason than the returns will go down in future as the DDT has been increased from next financial year. Systematic withdrawal Plan in MIP has also shown better returns than the Post Office monthly income scheme where the returns are fixed but are 100% taxable. On the other side debt mutual funds has always been a tax efficient investment option

 

How SWP was beneficial?

- SWP option has returned more as is visible through XIRR.

- SWP has reduced the taxation, as unlike Dividend option where DDT gets deducted, this leads to some Short/Long term capital gain/loss. Though it is not shown in the calculation above, but I am sure that it would surely be less than the DDT. Hope you agree with me.

- SWP has resulted in continuous and fixed cash flow stream and thus adequately supported the regular income criteria as required by Client.

 

Conclusion:

Well back testing clearly shows that Systematic withdrawal plan works better for Monthly Income plans to get regular income. But as per the standard disclaimer that "Mutual funds are subjected to market risk….",future can't be predicted. Moreover this calculation has been done on one of the top performing fund of the category, this may not result the same in other funds too. Overall, the bottom line is that looking at the increase in dividend distribution tax in debt schemes, systematic withdrawal plans should also be considered when the goal is to get monthly income in MIP funds.

Happy Investing!!

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