The MIP Mythbuster

Are you looking for a financial instrument that offers you better returns than the lowly bank fixed deposit? Are you looking for a fund that offers you a regular flow of income with low risk? Then in all probability, you’ll receive plenty of well-meant advice to go in for monthly income plans.

The common misconception with funds that carry the ‘monthly income plan’ tag is that these funds are best suited to generate a steady flow of income for those looking at alternatives to bank fixed deposits.

But watch out. Don’t invest in these funds for all the wrong reasons. Here are four myths about MIPs that we are happy to bust.

Just like any other mutual fund scheme, MIPs come with two options: growth and dividend. It is true that MIPs give you income in the form of dividends. You can also choose to receive dividends quarterly, half-yearly or annually.

But just as with any other mutual fund, there is no guarantee about the monthly income. This is because mutual fund regulations clearly state that fund dividends can be paid only from surpluses and not from the capital.

For instance, if the Net Asset Value (NAV) of the fund increases from ₹10 to ₹13, the fund can declare dividend only out of the ₹3 it has earned in capital appreciation.

Hence, if the fund’s NAV rises slowly or falls due to market swings, it may not declare dividends at all.

Of the 27-odd MIP funds that have been around for the past six years (since 2011), fewer than half have a track record of paying regular dividends (quarterly). This means you have less than a 50:50 chance of receiving regular dividends. In fact, some funds have been quite erratic with their dividend payments.

Bottomline:You cannot rely on MIPs alone for your regular living expenses

Generally, MIPs invest 70-80 per cent in debt instruments, such as government securities, corporate bonds, money market instruments and debentures and 20 per cent or so in equities. The equity part, as everyone is aware, is prone to volatility in the market.

The debt part, too, is not risk-free, contrary to what many believe. Returns from these funds are also subject to market swings and can be impacted by interest rate movements. For instance, if interest rates go up, older bonds become less attractive, leading to a drop in their prices. MIPs can record negative returns too.

Debt funds also invest in corporate bonds, and the credit quality of these bonds has a bearing on the fund’s returns. In case a bond faces default on its payments, a portion of the fund’s portfolio can be written off.

Hence, MIPs are not a substitute for your good old bank deposits. Your capital can get eroded; so go for it only if you are up for some risk.

Bottomline:If you are looking to park your funds for a short period — say, six months or a year — it may not be a good idea to invest in MIPs.

Your capital can erode, and leave you short of funds to meet your short-term obligation.

In an effort to entice investors, fund houses advertise the fact that MIPs offer “double-digit returns” . It’s true that top-performing MIPs have delivered double-digit returns over the long run.

But there is a catch. If you are looking for regular income and are considering the dividend option, you should not be misled by the NAV gains on the growth plan.

The 10-11 per cent returns that many good performing MIPs have delivered over the long run may be on the growth option, which does not pay out dividends. Instead they re-invest their gains in the fund. Thanks to the power of compounding, your returns from growth plans are far better than those under the same fund’s dividend option.

Remember, under a dividend option, the NAV falls to the extent of the dividend, after the payout is made. Hence, top-performing MIPs under the dividend (quarterly) option have typically delivered a modest 3-6 per cent (of course, over and above the dividend you receive).

Bottomline:If you prefer the growth option, there are other categories of debt and balanced funds that may offer better returns.

If your main aim while investing in MIPs is to earn returns superior to bank deposits, you may want to reconsider MIPs. Interest on your bank deposits are taxed at your slab rate. But MIPs are not particularly tax-efficient, either.

While dividends declared by debt funds are not taxable in the hands of the individual, all non-equity funds now attract a higher dividend distribution tax (DDT). The effective tax rate works out to 28.8 per cent. Hence, you may end up getting only ₹1.4 on a dividend of ₹2 declared by the fund. The NAV of the fund, though, gets adjusted to the extent of the gross dividend (₹2).

Bottomline:Taking DDT into account, the post-tax return on MIPs may not be attractive when compared to bank deposits, for people in the 10 per cent and 20 per cent tax bracket.

You ought, of course, to be aware of these common misconceptions that investors have regarding MIPs, but there is no case for avoiding MIPs altogether. With the stock market scaling new highs, investors should look at hybrid funds, such as MIPs that invest predominantly in debt but also take notable exposure to equity.

While the debt portion of the fund’s portfolio can help contain downside risk, the exposure to equity can give a booster shot to your returns in market rallies.

Birla Sun Life MIP II Wealth 25, for instance, has been investing about 70 per cent of its portfolio in debt, and has delivered steady and category-beating returns across time periods. The fund has been a consistent dividend payer. Investors who are not looking for a regular payout can consider the growth option of this fund, which can deliver double-digit returns over the long run.

Bottomline:Don’t neglect MIPs altogether. But make sure you invest in them for the right reasons.