The last few months, especially since December last year, has been a roller coaster ride for investors in the equity markets. After seeing a 5.6 % (1908 point) rise in the BSE Sensex in January 2018, there has been a 5.4% (1955 point) fall in the benchmark barometer till February 20. Close to a 4000-point movement over a period of less than two months can be a disturbing sign for a new investor, who has not observed and witnessed volatility in his investing journey. And what about those investors who have a secular cash flow from the equity markets by way of dividend through the balanced funds over the past many months?
Investing in mutual funds
Investing in mutual fund schemes over the last 24 months has gained momentum. One of the reasons is the drive towards financial investments and the lack of opportunities in other asset classes such as gold and real estate.The initial investors in the mutual find space took baby steps by investing lumpsum amounts of varying investment amounts, right from Rs 1000. Also, to attract disciplined and regular investing, Systematic Investment Plans ( SIPs) were promoted. This ensured cash inflow into the mutual fund schemes of various types like debt, equity and hybrid. One of the schemes within the hybrid category is the balanced fund category.
Dividend schemes for regular cash flow
Again in the last 24 months, the monthly dividend distribution scheme has attracted a lot of investors, especially those seeking monthly fixed returns or secular cashflow. But the point to be noted is that majority of the balanced funds have a hybrid asset allocation—with over 65% invested in equity and the rest in debt instruments. This, at times of market downturn, can result in the NAV of the scheme going down, which can lead to lower declaration of dividend and also cessation of dividend for a certain time period, till distributable reserves are in place, as per the Sebi guidelines.
Now with tax on dividend distribution @ 10%, as also tax on long term capital gains @ 10% in the equity scheme, the gains and the cash inflow in terms of dividend are no longer tax exempt. The dividend distribution in mutual fund schemes, especially the balanced fund schemes, had given the investors a false sense of complacency of guaranteed monthly dividends. However, if as an investor you do need a regular cash flow, it can be carried out through Systematic Withdrawal Plan (SWP).
Systematic Withdrawal Plan
In a SWP, on a specific date, a pre-determined amount is credited into the bank account of the investor, after redeeming the units of the mutual fund scheme. In fact, SWP is typically useful in the distribution phase of the investor. And it has not found traction in the investors mindset, as it has not been promoted, as a cash flow and/or distribution tool. In a dividend distribution, when the dividend is distributed NAV of the scheme falls. In a SWP, the number of units in the scheme of the investor is reduced.
As an overall investment strategy, an investor can park his cash flow needs into a liquid fund and then execute an SWP through the said scheme. This will ensure that the possibility of the capital being eroded by the volatility of the equity markets is reduced. And also ensure that the cash flow needs are met. This will also reduce the impact of volatility in the cash flow needs in the overall investment portfolio of the investor.
If the redemption is from a debt scheme and before three years, short term capital gain is applicable on the gain of the scheme. If the redemption is from equity schemes before one year, short-term capital gain tax is applicable and if redeemed after one year then long term capital gain tax is applicable. There are fixed instruments like tax-free bonds and fixed deposits. But typically, this has interest distribution at half-yearly intervals or more often at annual intervals. In a SWP, the distribution frequency can be set by the investor and this has an advantage over other fixed instruments.
The writer is managing partner,
BellWether Advisors LLP