As the interest rates are falling and
FD rates are moving southwards, It is becoming increasingly challenging to find
out other option which can be safer and also provide better returns from Bank
FDs. Investors especially retired persons who wants safety of their investments
and also regular income finds market volatility too hot to handle hybrid funds
with Systematic Withdrawal Plans (SWPs) set up for regular cash flow could be
better option which can still help investors fight inflation. Further a smart
option could be setting up SWPs on accrual funds, especially with funds that
have waived exit loads for SWPs.
Generally risk
averse investors continue to choose bank deposits as their preferred investment
option. Conservative people normally go for FDs after retirement, as the comfort
of a regular, predictable cash flow is very necessary at that stage of their
life. However in current environment where the interest rates are low and going
further downwards while inflation is sticky, , in the quest for safety of
capital, people land up unknowingly losing the fight against inflation,
consequently see the purchasing power of their fixed income eroding over time.
The challenge in
SWPs from hybrid funds
We all understand that
an element of equity in the retirement corpus can help retired people in the
long term to win the battle against inflation quite comfortably. However we should
not forget that the long term is also actually a series of short terms. Generally we wish that the equity component of
our investment would first appreciate so that we get a buffer and also insulate
us from significant market volatility so as to have a corpus which can fight
the inflation. However the equity market does not behave in such a simple and
systematic way and if the market moves up people may take out that money and
again put in FDs so as to get the required regular monthly Cashflow. The returns and appreciation from Balance and
other Hybrid funds may not be stable and hence quite challenging to continue
SWPs (Systematic withdrawal plans) from these funds, especially when the corpus
has gone into negative territory. For any investor the first priority is always
to resolve the anxiety of today rather than worry about what may happen 10
years down the line in terms of reduced purchasing power.
In this type of
situation what could the best solution in these circumstances? In this type of situation Debt Mutual Funds
could be an ideal option which are not complicated but have the potential to
give better returns than FDs and also have some, though not fully but have scope
to face the war against inflation. In Debt mutual funds an investor may not
create wealth, but at least may not erode his capital due to a combination of
inflation and taxes.
What are Debt
Mutual Funds:
- Debt mutual funds invest in Government Securities, Bonds and Corporate Debentures etc which promise regular fixed income on monthly quarterly annually or on maturity.
- Unlike Fixed Deposits interest, Dividend form Debt mutual funds are completely tax free. FD interest payments on the other hand attract tax Deducted on Source (TDS).
- Any Profit an investor make from Debt Funds after three years are adjusted for inflation and get the tax benefits of Long Term Capital Gain Tax.
- Debt funds are often classified as low or medium risk investments. This means the possibility of losses is low means safety to the capital.
- However all said done, debt funds do not promise a regular income. When interest rate rises prices of fixed income securities i.e. bonds falls. This could even lead to losses, leading to fall in overall returns.
The ideal option
for an investor who wants regular cash flows could be an SWP from a low
maturity debt fund. The primary objective of this plan is:
- Little volatility in returns and marked to market
valuations
- Low taxation, Since tax is only applicable on the
gain on the units redeemed every month not on the entire withdrawal amount
- Growth of principal over time
- Low reinvestment risk as fund managers manage the
average maturity of the fund and don’t take high duration risk
- No exit load on SWP amount, hence no charges for
monthly SWP
- Complete or partial liquidity as funds withdrawal is
possible within one day notice.
- Flexibility to increase or decrease the SWP amount
based on a person’s requirement and funds performance
- The other investment options with similar objectives are: Corporate Bonds, Corporate Fixed Deposits, Tax Free Bonds and LIC annuity plans.
Apart from Retired
persons there could be other people/organisations who may also have similar requirements
and find the debt mutual funds a better option those could be:
- Charitable Trusts and hospitals, who have large
trust corpus and need regular cash flow for meeting their obligations
- Gymkhanas and Clubs who have a large membership
corpus and require monthly income for meeting regular expenses for events,
maintenance and salaries
- Cooperative Housing Societies who have a deposit
corpus and need monthly income for meeting maintenance expenses
- Real Estate investors who look for rental income.
Here no hassle of finding tenants, following up for payments and paying
various taxes on the rent
- Corporates who have cash holdings and require a
regular income for various statutory expenses
- Individuals and families who have received an
inheritance or sold a property and are looking for a steady income
- Life insurance claimants, who have lost the
breadwinner. The insurance claim can be used to earn a steady monthly
income
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