What are Monthly Income Mutual Funds?
Monthly Income Mutual Funds or Monthly Income Plans (MIPs) are debt-oriented hybrid mutual funds that invest a small portion in equity instruments. The equity portion is considerably low to give an advantage of stability to the overall portfolio. The fund’s objective is to offer the investor steady cash flows every month. Usually, the returns are given out in the form of dividends, and the frequency of payout depends on the fund and investor – either monthly, quarterly, half-yearly or annually. Moreover, such income becomes an alternative source of income for investors like retirees or senior citizens.
In simple terms, MIPs are like fixed income funds that invest in debt instruments like government securities, commercial paper, t-bills and certificate of deposits. These instruments have different maturity dates and risk profiles. Hence, the fund focuses on having the right combination of risk and returns. Also, it invests a small portion in large, mid or small-cap stocks depending on the fund objective. Moreover, the income generated from these instruments is in the form of interest and dividends.
Features of Monthly Income Mutual Funds
The following are the key features of monthly income mutual funds –
- Portfolio Composition: The portfolio comprises 75-85% in debt instruments and the remaining 15-25% in equity instruments. This way, the fund manager can combine the profitability of stock markets with the stability of debt instruments.
- Different Plans: These mutual funds have growth and dividend options. The growth option is where your returns are compounded, while the income option gives periodic dividend payouts.
- Returns: MIPs have the potential to offer better returns than traditional savings instruments like fixed deposits or post office schemes. However, it is riskier than traditional instruments.
- No Limit: The scheme is flexible and has no upper limit on investment. Thus, investors do not have to pay any entry load or processing charges.
- Liquidity: This scheme has more liquidity in comparison to other schemes. Also, there is no lock-in period on investment. Investors can withdraw their funds anytime to meet unforeseen emergencies.
- Low Risk: The risk associated with these funds is lower as the underlying portfolio consists of low-risk securities like fixed income instruments, dividend yield stocks, etc.
Types of Monthly Income Plans (MIPs)
The following are two types of Monthly Income Plans –
MIP with Dividend Option
Under this option, investors receive income in the form of dividends. Investors can choose to receive this income either monthly, quarterly, half-yearly or yearly. Also, dividends are tax-free in the hands of investors. These dividends are paid from the distributable surplus by AMC and are paid when the respective fund earns profits.
MIP with Growth Option
Under this option, the earnings accrued on the capital get added to the investment amount. Hence, the money is just growing inside the fund, and investors can enjoy the benefit of the power of compounding. In the long term, it facilitates wealth creation along with capital growth.
How Does a Monthly Income Plan Work?
The monthly income mutual fund works similar to the dividend mutual funds. The fund manager invests in a portfolio of debt and equities. Whenever it makes a profit from the underlying securities in the portfolio, it distributes a certain percentage of profits to the investors in the form of dividends at its own discretion. This is how investors receive regular dividends from these funds. It is directly transferred electronically into their bank account. However, investors must note that the amount may vary depending on the market situation and fund performance.
Who Should Invest in Monthly Income Funds?
Monthly Income Funds are a perfect blend of risk and reward that makes a feasible investment option for investors looking for a steady source of income. Investors like retirees, senior citizens or homemakers who want a regular monthly income can plan for their unforeseen expenses because they have a limited source of income.
Investors with low-risk tolerance levels can consider investing in this fund as the portfolio has a significant allocation towards debt instruments. Thus, it enables investors to earn returns along with consistent income. However, investors must remember that MIPs do not guarantee fixed payouts every month. It may vary depending on the fund’s performance.
7 Things to Consider Before Investing
The following are the things to consider before investing in monthly income mutual funds –
Because of high exposure to debt instruments, this fund is influenced by interest rate and credit risk. A change in interest rate may lead to a change in the value of the bond price, which will impact the fund value. Furthermore, market fluctuations can also affect the stock prices in the portfolio, which can impact the returns. Therefore, investors must consider the credit rating of the underlying debt securities before investing in this fund.
Fund managers take advantage of interest rate volatility to generate returns for investors. Also, they tend to offer better returns than traditional investments, like a fixed deposit. However, it has to be noted that there are no guaranteed returns or fixed payments in monthly income plans.
Every fund has certain costs, which are in the form of the expense ratio and exit load. The expense ratio includes fund management fee, transaction costs, etc., which is charged through the fund NAV. This reduces the overall profit for investors. On the other hand, exit load is the charge the fund house deducts when the investor exits the fund before a specific time. Hence, investors must check whether the expense ratio is too high while investing in a monthly income mutual fund.
4. Investment Horizon
Generally, investors must have an investment horizon of 3+ to actually benefit from these funds. The fund manager takes advantage of interest rates and changing market conditions to offer returns to investors. However, this requires proper skills to manage the changing economic situations. Therefore, investors must ensure that their investment horizon is aligned with the fund’s investment horizon.
5. Investment Goals
The investment fund choice primarily depends on the investor’s goals, whether to stay invested or look for regular income. Therefore, investors must align their investment goals with the fund objective to enjoy the maximum benefits.
6. Fund Manager
A fund manager plays a crucial role as the investment strategy varies depending on the type of mutual fund. Also, a monthly income mutual fund is a hybrid fund with a combination of equity and debt. Therefore, there are different fund managers assigned to manage debt and equity separately. The debt fund manager chooses the securities based on credit rating and average maturity. The equity fund manager chooses securities based on the fundamental analysis. These aspects are available in the scheme documents. Investors must check this information and the past track record before investing.
7. Financial Ratios
An investor can analyse a mutual fund based on different performance ratios. These ratios are standard deviation, beta, Sharpe, alpha, etc. These ratios help to measure the performance and compare it with other mutual funds within the category.
Tax Implications for Monthly Income Mutual Funds
Because monthly income mutual funds primarily invest in debt securities, the taxation will be the same as the debt-oriented mutual fund. Taxation of debt mutual funds till March 31st 2023 is as follows:
If the fund’s holding period is more than three years (36 months), then capital gains are taxable at 20% with indexation benefit.
Short-Term Capital Gains (STCG)
If the holding period is less than three years (36 months), capital gains are added to the total income. The total income is taxable as per the investor’s income slab rate.
From April 1st 2023, debt funds no longer have LTCG benefit. As per the Finance Bill 2023, capital gains arising from debt investments from April 1st 2023, will be taxed as per the investor’s IT slab rate, irrespective of the holding period.
The dividends that investors earn do not attract any tax. However, the fund houses levy a 25% dividend distribution tax (DDT) before distributing the accrued dividends.