Wednesday 15 March 2017

Financial Planning through Mutual Fund Investment

Some of you must have confronted with a major question that makes you jittery while you're investing in mutual funds : “What is the time horizon for my investment?” This helps your financial advisor in recommending you an appropriate asset class and product.

Taking an example of Mr. Abdul who is about to change his job and have got a fatty cheque of Rs. 5 lakhs from his former employer towards several perks such as unclaimed leave and expense reimbursement. Now he wishes to put this money in bank fixed deposit but he consulted his friend Mr. Ken, a financial advisor for his expert opinion.

Mutual Funds

Ken suggested Abdul, who wants this money for his daughter's marriage, which could have been used anywhere between 6 months or within 5 years time, stated that only as a composition of liquid funds, MIPs and arbitrage funds can help him , but not an FD.

Abdul expressed his astonishment over mutual funds since he was told that mutual funds are only for long term horizon of 5 years and above. And now he is suggested only to consider mutual fund investment.

Ken cleared Abdul's exaggeration over mutual fund investment stating that there's much more to mutual funds as it's normally been seen that people equate mutual funds with equity only. Later on, Abdul asked for a bit elaboration so here we get started with Mutual Fund Investment through Liquid Funds.

Liquid Funds-

Investment in Liquid funds ranges in call money markets, treasury bills, certificate of deposits and commercial paper. Since investment is made with instruments in high credit ratings, it carries very low risk.

And even after levying a Short Term Capital Gains Tax at your Income tax slab, liquid funds offer better returns than SB on post-tax basis(7% to 9% for the past 3-4 years). Liquid Funds have no exit load too.

While you decide where to employ your money, rather than putting in an SB account, invest it in liquid funds.

Ultra Short Term Funds-

You can go for Ultra Short Term funds(formerly known as Liquid Plus Funds) when your time horizon is somewhat more than 3 months but say less than 12 months.
These funds can generate better returns, inspite of being more volatile than liquid funds. But these funds levy exit loads and are comparatively volatile though not as much as Income Funds.
Income Funds-

If your investment horizon spans around for more than 12 months, say up to 3 years, you can consider income funds. Income funds provide you higher returns in contrast to Liquid Funds, but they pose volatility and are definitely not for low-risk takers. They invest in a composition of bonds, corporate bonds, commercial paper, gilt funds etc.

A word of caution: they are very volatile and levy exit loads, so be cautious about your investment horizon. But yes, they are absolutely lower than the penalty imposed by banks in matters pertaining to premature withdrawal.

Gilt Funds-

Abdul informed Ken that he has heard of a debt fund category known as gilt funds which invest only in government securities. He expressed his plans of considering it for investment, as capital safety is guaranteed.

Ken makes him aware of the possibility of delivering capital loss on his investments in case of rising rates. He further revealed that there are no chances for the default in such funds, provided Abdul needs to stay for a longer time horizon in order for not losing his capital amount.

Fixed Maturity Plans(FMPs)-

Another alternative for your investment is the Fixed Maturity Plans. FMPs are identical to fixed deposits wherein money is invested in fixed income securities with good rating and are more tax efficient as compared to FDs due to benefits of indexation.
Moreover, with FMPs, you will be able to get stabilized returns along with locking your money at higher rates. FMPs are extremely secured too.
Monthly Income Plans-

Don't go by the term stated as Monthly Income Plans. They do not assure you any income on a monthly basis. MIPs are capable of delivering higher inflation adjusted return due to their marginal equity exposure of 10% to 25%.
So, if you have a stamina of taking a slightly higher equity risk, then you can surely prefer these MIPs as these have a capability of providing you double digit returns, especially if your time horizon spans for more than 3 years.
Arbitrage Funds

One category not to avoid is of arbitrage funds. These funds are treated like equity funds and provide returns at par with liquid funds. In fact, the market effect drops little to nil on this category. Arbitrage funds have provided post- tax returns in the range of 8% – 9%.

You can choose for getting invested in arbitrage fund with dividend option and then switch the dividend into a balanced or large cap fund. This should provide you tax-free returns exceeding the double digit for your time frame of 5 years.

Lastly, all these debt MFs are held for 3 years, so indexation benefit is permitted wherein you will be taxed only for the returns earned besides the inflation rate. And arbitrage funds are treated like equity funds and if held for 1 year or more carries no capital gains.

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