Capital appreciation and income are two primary investment goals. Mutual funds provide a multitude of investment solutions for both these objectives for different risk profiles. However, in India mutual funds are mostly associated with capital appreciation. A retail investor’s faith in mutual funds for wealth creation has been well-rewarded, with good equity mutual funds giving multiple times returns over a sufficiently long investment period.

The main purpose of investing, for many investors, is capital appreciation or wealth creation; investing for regular income is not an important consideration for majority of investors, except senior citizens. Most mutual fund investors in India belong to the salaried class and they depend almost entirely on their salary for meeting their regular expenses. Be that as it may, monthly income, whether from salary or investments, is the most important financial need for all of us.

Let us take a typical salaried person in his mid to late thirties or early forties in the upper middle income group. Consider his regular monthly expenses – home loan EMIs, fees for school going children, utility bills, fuel bills, grocery bills, salaries of household staff etc. Most of these expenses are fixed expenses and you simply cannot wish them away. Let us now ask the very uncomfortable question. What if he does not get his salary next month? He may have enough balance in his savings account to take care of his monthly expenses for a few months.

Eventually he would have run out of liquidity and have started redeeming his investments (fixed deposits, mutual funds, etc.) If unfortunately the market crashes at the same time (bad luck often strikes on multiple fronts), then he will be selling his mutual funds at a low price or even at a loss. He could find a new job, but until then his investments may have depleted considerably and it may take the investor a very long time to return to comfortable levels of savings/ investments, not to mention the severe mental stress, the investor and his family had to go through.

Safeguarding from loss of income

How can investors safeguard themselves from such a situation? In the developed countries like USA, Canada, UK etc. there are general insurance products which can provide income replacement if the insured loses his or her job, but unfortunately at present there are no unemployment insurance products in India. Investors should therefore, look for investment solutions for regular income. Fixed deposits paying monthly interest and Post Office Monthly Income Schemes were traditional investment choices for income in India. However, interest rates of these traditional fixed income products have fallen over the last 2 years and as such these products may not be able to generate sufficient income for your needs. Investors need to look at alternate income investing solutions and mutual funds provide such a solution to investors.

Before we discuss income investing solutions, it is important to understand that income producing assets are low or moderately low risk assets and therefore, investors should not expect very high returns from these investments. Further, since the income yield is not very high, it may take a considerable amount of assets to generate sufficient income to replace your monthly salary. But investing in income producing assets is a step towards financial independence. If your investment income can meet, say 20% of your fixed monthly expenses, pressure on your other assets will be considerably lesser during periods of no salaries.

Who should invest in income generating assets?

There is a misconception that only retired people should invest in income generating assets. Even if you are working, you should invest in income generating assets. You should ask yourself, how much flexibility you have in expenses – a very large part of the expenses of most families are inflexible. Such families should therefore, invest in income generating assets. You should look at your financial liabilities like home loans, car loans etc. You should also look at your family obligations – school going children, dependent parents etc. The higher your financial liabilities and other obligations are, the more you should invest in income generating assets.

Mutual fund income solutions

Mutual Fund Monthly Income Plans are excellent investment choices for investors looking for income and also some capital appreciation over a sufficiently long investment period. Monthly Income Plans are debt oriented hybrid mutual fund schemes where debt allocation can range from 75 to 95% and the equity allocation can range from 5 to 25%. You can choose between lower and higher equity allocations based on your risk appetite. For example, younger investors can opt for higher equity exposure, while older investors canopt for lower equity exposure.

The primary objective of Monthly Income Plans is to provide regular income to investors along with some capital appreciation over a sufficiently long investment tenure. The capital appreciation can help investors beat inflation in the long term. The debt component of Monthly Income Plans lowers the volatility, provides stability and generates income for investors. The equity portion provides a kicker to returns over a sufficiently long investment horizon and can help investors beat inflation.

Both Growth and Dividend options are available in Monthly Income Plans. Unless you have immediate income needs, you should invest in the Growth option so that you can benefit from compounding. When you need income from your investments, you can switch from Growth to Dividend and start receiving regular monthly payouts. Investors should understand that, though Monthly Income Plans aim to payout regular dividends to investors, mutual fund dividends are not assured.

Difference between Monthly Income Plans and Balanced Funds paying monthly dividends

Both Monthly Income Plans and Balanced Funds of many AMCs are paying monthly dividends for the last few years. The monthly dividend payout rates of Balanced Funds have been a few percentage points higher than that of Monthly Income Plans. However, you should understand that the risk profiles of these two types of mutual funds are very different. Balanced funds have at least 65% exposure to equities and the rest in fixed income. Monthly Income Plans, on the other hand, have only 5 to 25% exposure to equities. Lower equity exposure makes Monthly Income Plans much less volatile compared to Balanced Funds.

Let us also understand how Monthly Income Plans and Balanced Funds pay regular dividends. Monthly Income Plans ideally aim to pay dividends from income accrued by investments, e.g. interest earned from debt securities. Balanced Funds on the other hand are paying monthly dividends from their accumulated profits earned through portfolio churning, i.e. buying and selling stocks and bonds. Over the years, the older Balanced Funds have paid out only a portion of their profits as dividends, keeping the rest of the profits in reserve to be paid out on rainy days. But you should understand that Balanced Funds are more affected by stock market volatility and their ability to pay dividends has market dependency. Monthly Income Plans, on the other hand, get their income primarily from debt securities and therefore, provide much greater income stability.

Dividend taxation

One of the main reasons of higher dividend payout rates by Balanced Funds is because of the tax advantage these funds enjoy over Monthly Income Plans. Balanced Funds are taxed as equity funds and dividends paid out will be taxed at 10% by way of dividend distribution tax (DDT). Dividends paid by Monthly Income Plans, which are treated as debt funds, are subject to DDT of 28.8%. These rates are exclusive of surcharge and health and education cess.

Capital Gains Tax in Monthly Income Plans

Short term capital gains (investment holding period of less than 3 years) in Monthly Income Plans are taxed as per the income tax rate of the investor; long term capital gains (investment holding period of less than 3 years) are taxed at 20% after indexation. Indexation benefits can reduce the effective tax rate of the investors substantially.

Long term capital gains tax advantage makes Systematic Withdrawal Plan (SWP) in Monthly Income Plans more tax efficient than monthly dividends. However, the SWP rate should not be more than the long term average rate of return of the fund; otherwise you may end up depleting your investment and this will defeat the purpose of income investing. Top performing Monthly Income Plans have given nearly double digit returns over the past 5 to 10 years, but in our view you should limit your withdrawal to 8% per annum. Once your corpus grows, you can then increase your withdrawal rate.

Conclusion

Your portfolio should comprise of both growth assets (for capital appreciation) and income generating assets. Growth assets will create wealth for you, while income generating assets will provide stability in difficult times. Monthly Income Plans are excellent income generating assets for long term investors. You can invest in Monthly Income Plans either as a lump sum or using Systematic Investment Plans (SIP).

We advocate SIP as a disciplined investing mode for salaried investors. Over a sufficiently long period of time, through SIPs, you can accumulate a sufficiently large asset base, which can take care of a large part of your income needs. Investors should consult with their financial advisors if Monthly Income Plans are suitable for their investment needs.

A Systematic Investment Plan (SIP) is a small, regular investment in mutual funds for a fixed time period.

Suppose you want to have 5,00,000 in 5 years for a car. Just like you’d save little by little to build a corpus to purchase it, you can start a SIP in a mutual fund for it. There are several advantages a SIP gives you over regular savings, the potential to earn higher returns being the foremost.

What are the benefits of a SIP?

1. SIPs make sure you invest regularly – With a SIP, you set your investing on auto-pilot I.e. a predetermined sum of money is invested on a fixed date for the time frame and period you’ve selected. SIPs on a monthly basis are the most common.
2. Start small with a SIP– You can start investing with as little as 500. There is no limit on the maximum you can invest. Every small instalment will contribute to your overall corpus.
3. SIPs give you flexibility– You can choose your SIP amount, date of debit, frequency of SIP and the period until which your SIP should run.
4. SIPs allow you to average out investment costs– When you purchase units of a mutual fund, you get each unit at the NAV (price per unit). This NAV depends on the performance of the scheme and is subject to change. So, when you invest periodically through a SIP, for the same amount you could be purchasing units at different NAVs, thus averaging out investment costs. When the NAV is low, you’ll get more units for the same amount, and vice versa. Here’s an example:

5. Variety of SIPs– Investors have several options when it comes to setting up SIPs. Apart from the regular SIPs, they can choose from Flexi-SIPs and Step-up SIPs too. A Step-up SIP increases your SIP by an amount you fixed at an interval you fix – say if your current SIP is 1000, you can choose to step this up by another 1000 annually. So, from year two, your SIP amount is 2000, year 3 it is 3000 and so on. With a Flexi-SIP, you invest a fixed amount regularly like a SIP, but can invest more when the markets are falling subject to a maximum limit you choose, lesser when markets are rising subject to the minimum investment value of the fund.

Reaching your financial goals is so much easier with a SIP. Start one today, and march one step at a time to wealth.

How do millennials view savings or investments? This is a reasonably common topic of discussion in today’s world of financial planning.

If there’s one activity that we all tend to postpone and defer, it’s retirement planning. Most of us tend to underestimate the perils of poor retirement planning or the lack of a meaningful corpus at the time of retirement.

30s to 40s is typically when an individual has achieved a certain level of stability in both their personal and professional life. There is a sense of rationality, balance, and maturity that an individual typically attains. The key step in financial planning is estimating post-retirement expenses. One mistake that most people make in projecting cash-flow requirements post retirement is visualising a downsizing in lifestyle and consumption needs in post-retirement life. Consequently, they project lower ‘real cash’ flow needs. This to me is the biggest mistake most people tend to make.

The golden rules of estimating post-retirement expenses

1. Factor in inflation – that’s what ‘real money’ means – and factor in real inflation. Let your retirement calculations assume inflation at nothing less than 7% CAGR. It is always better to be on the higher side. If the inflation isn’t as high as you projected, you will have more funds in hand. However, if your projections are substantially lower, you will be in dire straits. Here’s a real scenario: To generate Rs.6,250 on a monthly basis, you would have needed a corpus of Rs.12,50,000 30 years ago. Today, you would need a corpus of Rs.1 crore to generate a monthly income of Rs.50,000. That’s the impact of inflation. (Inflation rate – 7.19% for 30 years computed based on Cost of Inflation Index, source: www.incometaxindia.gov.in; Monthly interest assumed at 6% p.a)

2. Assume no clamp down in lifestyle and consumption needs. Human beings are inherently averse to accepting change. This is more so the case when it is a scale down instead of a scale up. Moreover, there will always be additional lifestyle expenses that come with age than you may think of as necessary now.

3. Prioritise your expenses into three categories – must have, nice to have, and can do without. Try to live without the ‘can do without’ before you retire. This will help you address the previous point as well as give you a more realistic picture of what your expenses are like currently and what they could be like in the foreseeable future.

4. Project your expenses into monthly payouts and annual payouts. Annual payouts include things like Car Insurance, Medical Insurance, home-care initiatives like pest control and AC annual maintenance. Factor in all the expenses you undertake on an annual basis.

5. Build capex spends. For instance, you will need to replace your car once in 5 years, will need a TV once in 8 years, a mobile once in 3 years, and so on. These can be a major drain post retirement.

6. Once you arrive at these factors, sum these up and back-calculate when you intend to retire. Project a realistic life span for yourself of at least 80 years at the minimum. Now use these numbers to calculate your corpus.

7. Break this corpus into yearly and monthly expenses.

8. The above computation assumes that you have adequate Medical Insurance. Medical expenses are a major expense, especially post retirement, and you need to have a comprehensive medical policy that covers you and your spouse in case of eventualities. This is extremely important as an ineffective policy or lack of a medical insurance can throw all your plans out of kilter since the need for medical intervention and scope of medical expense is very difficult to predict.

Where do I invest for retirement?

There are many options available in the market including dedicated Pension Schemes. But for now, I’d like to emphasise that every retirement investment portfolio must have a significant allocation to equity.

Equity is the best asset class to beat inflation in the long run. Equity mutual funds in India have generated close to 15% – 17% CAGR over the past 10 years. That’s about 8% to 9% above inflation. When you compound this annually, it gives you a significant amount of wealth over an extended period of time. Here’s a fact – Over the past 40 years, an investment of Rs 10,000 in the S&P BSE Sensex would have grown to over Rs 45,28,568 (data as of March 31, 2019)

The typical approach is, the longer the period for retirement, the greater the allocation to equity. Individuals who are less than 40 years of age should have about 80% of their investments in equity and the assumption is at least 40% of their income goes towards investment products. My observation is that anything less than these numbers will always lead towards a sub-optimal post-retirement corpus.

To summarise,

1. Start early. Ideally, start from your very first year of work. The same old parents-to-children golden rule works in this situation as well – do not postpone important activities. Retirement planning is a supremely important activity and something that young India will do well to register on their priority list.

Project a realistic retirement age. Just because our fathers and grandfathers retired at 60 years does not guarantee that we will retire at 60 too. Be realistic about your retirement age

Creating a substantial retirement corpus is a crucial aspect of financial planning. This is to ensure that you have adequate funds to meet your various expenses during your retirement. With this in focus, the Indian government launched the National Pension Scheme (NPS) to provide investors with an opportunity to take care of their life, post their retirement.

What is NPS?

The National Pension System (NPS) is a government-backed pension scheme. It was first launched in 2004 solely for government employees. However, the scheme opened up to every investor in the country in 2009. The goal of NPS is to provide financial security to investors in their old age.

How does NPS work?

Under the NPS investment scheme, you can make investments towards your pension account on a regular basis during your working life. And when you reach your retirement age, you can withdraw a portion of the fund as a lump sum. The remaining portion is used to purchase an annuity so you can benefit from a regular income during your retirement years.

You can join the NPS scheme voluntarily, or you can opt for the plan offered by your employer. If your company provides NPS, it matches your investment and makes an equal contribution to the fund. Professional fund managers regulated by the Pension Fund Regulatory and Development Authority (PFRDA) invest your funds in different portfolios. This includes government bonds, shares and corporate debentures.

Who can invest in NPS?

All Indian citizens between the ages of 18 to 60 are eligible to make investments in NPS. So, irrespective of whether you are a government employee, private employee or self-employed, you can invest in NPS. This includes Non-Resident Indians (NRIs) as well. The only condition for joining the scheme is that you must fulfil all the necessary Know Your Customer (KYC) requirements to be eligible. When you open your NPS account, you are provided with a unique 12-digit number known as the Permanent Retirement Account Number (PRAN).

Pros and cons of investing in NPS

Like all the other investment avenues, the NPS too has its pros and cons. These are:

Pros

• The NPS is a voluntary scheme open for all Indians adults to invest
• It is highly flexible because you have the freedom to choose your asset allocation between equity and debt based on your investment requirements
• You can invest as much as you want each year. There is no limit on the maximum investment limit
• You can operate your account from anywhere in the country
• The 60% corpus that you withdraw on retirement is tax-free

Cons

• No guarantee on the rate of return
• While there is no maximum limit, you need to make a minimum yearly contribution of Rs. 6,000 to ensure that your account is active

What are the investment choices available in NPS?

The NPS offers two choices:

• Active Choice: You can decide how the money should be invested in different assets. This includes a combination of stocks, fixed income instruments and government securities.
• Auto choice: This is the default option where your money is automatically invested in different avenues based on your age.

Tax benefits

Every investor can claim a tax deduction of up to 10% of gross income under Section 80CCD (1) of the Income Tax Act. This is within the overall ceiling of Rs. 1.5 lakh permitted under Section 80C and Section 80CCE. In addition, the contribution made by your employer is exempted under Section 80CCD (2). You can also claim an additional deduction of Rs. 50,000 under Section 80CCD (1B).

Conclusion

If you’re planning your retirement, you can consider investing in NPS as an option for your golden years. But do ensure that you have a healthy mix of equity and debt in your other investments to help you build wealth.

As a TV viewer, it is likely that you have come across mutual fund commercials that end with the disclaimer: “Mutual fund investments are subject to market risks. Please read the offer document carefully before investing.” Does this disclaimer serve as a deterrent for you to invest in mutual funds because of the “risk factor”? Do you fear the loss of capital due to market volatility, and thus maintain an arm’s distance from mutual funds? If you are answering in the affirmative, here is what you need to know about mutual fund risks.

Decoding market risk

Like any other investment option, mutual fund investments too are subject to varying degrees of risk. The most significant of these is market risk or volatility. Volatility is the fluctuation in the prices of stocks or bonds. That’s because stocks or bonds are market-related instruments that react to economic events such as changes in interest rate or policy changes, geopolitical events such as war-like conditions, or inflationary risks- where the purchasing power of assets are reduced due to rising costs of goods and services. Volatility is an involuntary risk that all market instruments are subject to.

Different funds, different risks

Different mutual funds contain different kinds of asset classes in order to meet certain investment objectives. To meet these objectives, fund managers take some calculated risks. For instance, while equity-oriented funds may seem susceptible to short-term volatility, they can deliver superior returns beating inflationary risks over the long-term. Equity funds can, thus, be used to create wealth in the long run.

On the other hand, debt-oriented funds such as liquid funds are exposed to a far lesser degree of risk as compared to equity funds and therefore generate returns in line with the risk taken. However, the investment objective of these funds is capital protection and stable returns. The returns in this case may not be as high as equity funds.

Make informed investment decisions

As an investor, the first step you need to take is to assess your own financial goals and chalk out a financial plan. A good financial plan will help you understand how long you have to meet your goals. It helps you set a timeframe and a target.

The final step is to make an informed investment decision according to your risk appetite. Therefore, there is no one-size-fits-all policy when it comes to investing in mutual funds. Each investor must take a calculated amount of risk based on his individual circumstances. For instance, if you are just starting out in your career, you may be more willing to ride the ups and downs in the market to create wealth over a longer timeframe, as compared to someone closer to his retirement who may be concerned about capital protection and a regular stream of income, especially in his retirement years. He may be willing to accept a far lesser degree of risk.

The last word

To conclude, in the words of Warren Buffet: “Risk comes from not knowing what you are doing.” Buffet reinforces that as an investor that you are susceptible to risks only if you are not working with an investment plan and your investment decisions are not in sync with your financial goals. It is fair to say that when you are using your financial goals and the timeframe to meet these goals as a guiding star to assess the level of risk you are comfortable with, some risks may seem worth taking.

As investors, we always want to make sure that our investments give us the best returns. We look at performance numbers, fund rankings and what not to ensure that we invest in the best fund there is. But, there’s a difference between choosing the best fund and the best fund for you.

What’s this difference? The best fund in the market may not necessarily meet your investment needs.

So then, how do you choose the fund that is just right for you? Here’s a little checklist:

1. Assess your investment goals, timeframe and risk appetite

When you know what your financial goal is, how long you’re investing for and how much risk you can take, you can narrow down funds from the existing universe to invest in. For example: You may want a car that costs 5,00,000 in 3 years and you don’t want a fund that has many extreme ups and downs. With this in mind, a mid- or a small-cap fund is not the right fund to invest in even though it may have delivered the highest returns that year. A balanced hybrid fund may be a better choice.

Check out our blogs on equity, debt and hybrid mutual funds to understand which funds suit what needs.

2. Investment objective of the fund

There’s two ways to look at this: a) is your goal capital appreciation or income generation? b) where does your fund invest? If your goal is capital appreciation over the long term, look at funds that invest in in companies that are growing or have the potential to grow, or ones that are undervalued at the current market price. If your goal is income generation, short term debt funds or liquid funds are what you could consider.

3. Evaluating the fund and the manager

There’s plenty of information available today on the performance of funds and fund managers.

When it comes to fund performance, there’s two things to look at: performance of the fund against the benchmark, and consistency in fund performance. Has the fund beaten its benchmark year on year? Has it done better relative to its peers?

As for the fund manager’s track record, looking at it will give you an idea of how he’s managed the fund in bullish and bearish phases of the markets. Looking at rolling returns of the fund will give you an idea of the least possible, median, and highest possible return of the fund for a timeframe. This data is not readily available, and you can ask your financial advisor or the AMC for it.

4. Expense ratios

Expense ratio is the fee the fund house charges you to manage the operations of your fund. This is deducted from the NAV of the fund before it is reported. It’s good to know what your fund is charging you, but it isn’t much of a detrimental factor. Having said that, if you’ve two funds and all else being similar i.e. portfolio, AUM, returns, etc., and one fund charges you a lesser expense ratio over the other, you may opt for that fund after discussing with your financial advisor.

5. Review your Asset Allocation

When you pick a fund for your portfolio, you need to keep in mind that it fits the portfolio allocation that you’re trying to achieve with your investments. This is because by adding it to your portfolio, you may skew your asset allocation and take on more risk than required or lesser risk to be able to generate the kind of returns you want.

Picking a mutual fund to invest in may seem like quite a task but understanding your goals and choosing a fund in line with them can make all the difference to your portfolio. You can always talk to a financial advisor for help with choosing the right fund.