A few weeks back, investor Thiyagarajan Chandrasekaran posted on a popular financial portal ‘there is no dividend for the month of December-18 and February-19’. Thiyagarajan had put his hard-earned money in a top-rated balanced scheme of a mutual fund and was surprised to know that monthly dividends were not guaranteed.
He primarily opted for balanced funds (as against that of bank FDs) to improve his monthly inflows. However, little did he know that its dividends were subject to fund performance.
Bank FDs are considered safe by most investors. But they are also not tax-efficient since interest income is taxable at investor’s tax slab rate (30% on the higher side). While dividends from balanced funds are taxed at a lower rate of 10%, it is also subject to NAV performance.
To be frank, bank FDs and balanced funds have different risk-return profiles and are strictly not comparable. Balanced funds take riskier bets by investing into equities and thus become a promising avenue to earn higher returns than that of bank FDs. Its incremental returns come from taking additional risks.
Most balanced funds that are currently available in the market invest into equities to avail tax benefits. As per SEBI rules, they are classified as ‘aggressive hybrid funds’ which invests anywhere between 65%-80% of its assets into equities and the balance 20%-35% into debt instruments.
Dividends from these equity-oriented schemes are taxed at a lower rate of 10% as against 20% for debt-based schemes. However, in the process, their NAV also vacillates with the stock market movements without providing the stability of a debt oriented product.
Also, unlike other categories of equity funds (say large cap equity funds), where the investment basket is clearly delineated, for balanced funds, investment options can be wide open. Some balanced funds in the past have taken higher risk than their peers by investing more in mid cap and small cap companies. Others, have taken duration calls on their debt portfolio to benefit from the interest rate movements in the economy.
Distorted Asset Allocation
Last but not the least, investing in balanced funds can unknowingly tweak your asset allocation strategies. With asset allocation of balanced funds remaining dynamic, it’s likely you might be overinvested or underinvested into equities than you thought otherwise.
While one could argue about the lower tax status of balanced funds (as against that of debt-based funds), it’s hardly a trigger for investing. Investors are better off investing in a combination of pure equity funds and debt funds to arrive at the intended asset allocation mix. By planning for capital gains, over income, it can be made more tax efficient.
In short, reevaluate your investments into balanced funds. If you can stomach the ups and downs of the market and also seek high returns, go for pure equity funds. As William Shakespeare would say, what’s in a name?