It is an oft-misunderstood mutual fund category. Monthly income plans (or MIPs) are debt-oriented mutual funds, which is to say that they invest at least 75-85% of their portfolio in debt instruments and hold the rest in equities. Here are five things you should know about MIPs.
1. They aren’t really regular income products: Their name would have you believe that they generate regular monthly income. Now, the ‘income’ in MIPs is simply the dividend declared by the fund. Barring a couple, all MIPs offer several variants on the dividend option – monthly, quarterly, half-yearly, and annual. However, remember that dividend for any mutual fund can be declared only from the surplus the fund generates. This surplus will fluctuate depending on the debt and equity markets, and therefore, MIPs will not be able to maintain a steady surplus at all times. This has two consequences. First, the actual amount of dividend you receive can vary each month. If a fund declares Rs 0.05 dividend per unit for three months in a row, it can suddenly jump to declaring say, Rs 0.09 for the next couple of months, or even drop to, say, Rs 0.04. Second, if it does not have a big enough surplus or if the markets are especially turbulent, the fund can skip out on paying dividend altogether. Going by the dividend history, there are MIPs that have refrained from paying dividends in some months.
2. They do not have uniform risk: MIPs are slightly higher risk than pure debt funds. MIPs invest across debt instruments (gilts, bonds and debentures, commercial paper, certificate of deposits and so on), and each fund has a different strategy. Their portfolio make-up depending on opportunities and the interest rate cycle will impact returns over the years. For example, government securities looked attractive from last year with hopes of a rate cut. That gilt rally expectation panned out only over the past four months, resulting in funds that had upped gilt exposure significantly in 2015 floundering until then. On the equity side, MIPs do not have a uniform exposure. Those such as Birla MIP II Wealth 25, ICICI Prudential MIP 25, Canara Robeco Monthly Income Plan, all go up to 25% in equities; the first two have even gone up to 30%. Then there are those such as Birla Sun Life MIP II Savings 5 and HDFC Multiple Yield 2005, which put a maximum of 10-15% in equity. Thus, MIPs are not all at the same risk level. The extent of equity exposure influences fund volatility and returns. Higher equity can deliver superior returns, but such MIPs require a higher risk appetite than others.
3. They require at least 2 years: Because of their equity exposure and their average maturities of 2-3 years, MIPs do require you to hold them for 2 years at least to generate the best returns. Rolling one-year returns every day over the past ten years shows that most MIPs have delivered losses around 5-9% of the time, especially where equity holding is higher. Extending the holding period to 2 years removes the probability of losses, except for those with the highest equity exposure. MIPs also have exit loads on holding for less than a year; some impose loads on longer periods of up to 2 years.
4. They are subject to taxes: Since they are debt-oriented funds, MIP dividends are subject to dividend distribution tax at 28.84%. The AMC deducts this tax on your behalf. On holding periods of less than three years, your gains are taxed at your slab rate. On holding for above 3 years, gains are taxed at 20% with indexation. Your tax slab, your holding period, and your cash flow needs will determine whether to go for the growth, dividend, dividend reinvestment option. You can get a detailed explanation on which option to go for in this blog post.
5. They are suitable for generating FD-plus returns: For the higher risk taken due to the equity component and higher-yielding debt instruments, MIPs are able to generate returns superior to traditional instruments such as fixed deposits and are more tax efficient. Thus, if you have a 3-year timeframe for your investment, MIPs are a good fit. MIPs also suit conservative investors who don’t want to plunge into the stock market, but still want some higher returns. For those looking for dividend, it is best to stick to funds with a record of regular dividend payments, especially during turbulent periods such as 2008 and mid-2013. Even so, don’t consider MIP dividends for your sole cash flow source. In fact, the best way to ensure a steady monthly flow from your MIP is to do a systematic withdrawal.
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