Recently, I am regularly getting query from the clients to confirm that there is a fund which is paying 1% TAX FREE monthly dividend and whether to invest in for the same. Most of these clients are those who want to shift the fund from their either bank deposit or post office deposit as there is low interest rates offered, which not acceptable to investors.
I would like to clarify few of the myths or the impression which the investors are carrying with balanced category of mutual fund with them.
Let us understand the structure of mutual fund and the SEBI rule for the dividend policy. All the balanced funds are open ended schemes and hence any investors can invest and redeem the fund at any point of time.
Further, as the SEBI law, the dividends can be paid only out of the realized gains. To simplify, if the fund has started with the NAV of Rs. 10, this has been appreciated to Rs.15 over a period of time. Now this appreciation will have to components; one is they would have book the profit of say Rs.1/- by actually selling the investments and Rs. 4/- would be due to appreciation in the investments but till the date they have not sell the investments and realized the profits. Now they can declare dividend of Rs. 1/- only, which is their realized gains!!! Yes you can redeem the capital appreciation if any at any point of time. But at present the reality is that the fund is generating the profits by any means and they pay the same entirely leaving any capital appreciation.
One of the clients told that he was informed that if he invests Rs 1 lac then he will be getting credit of Rs. 1,000/- every month in his bank account as a TAX FREE dividend.
I think there is a big communication gap created. First this is not a fixed deposit product where there can be assured TAX FREE dividend. Secondly the mutual fund declared the dividend on per unit basis. Now the NAV of the fund is fluctuating daily and hence, if you have purchased long ago with low NAV your dividend yield would be high and if your purchase is at high NAV then naturally your dividend yield will be low!!
Let us now understand the component of investments of the schemes. Being equity category balanced funds; they have to keep minimum 65% of investments into equity. The range is of 65% to 75% in equity. Looking to the component of the scheme you will agree that the saga of regular tax free dividend payout of 1% cannot continue lifelong!! The communication done to prospective clients!!
Regular dividend is not bad but the communication that you will get it lifelong is worry some. Some day when the dividend will be missed and the client has a bad experience, he will again go back to bank fixed deposit, because he is getting what is communicated.
The investors are also at the fault to some extent. They should first check the qualifications of advisors and his experience in the field. To my experience, most of the people marketing this produce as lifelong tax free dividend of 1% are either the bank RMs or the new advisors who are being trained to show the past history of the fund.
But the mutual fund industry is always talking that the past performance of the schemes managed by the mutual funds is not necessarily indicative of future performance of the scheme. Mutual Fund investments are subject to market risks. Please read the Scheme Information Document carefully for details on risk factors before investment.
It is also the onus of the mutual funds and distributors clearly to explain the composition of the scheme and the risk factors involved in the same. The advizors and the investors are new but the mutual fund industry is now old and they have experienced the same in the MIP category few years back.
What should be done by the investors?
The first and the foremost principle of investments is there is no free lunch and hence you need to understant what is the risk of investments in particular scheme.
The first and the foremost thing is that after appreaing for the risk profile they should understand their risk taking and bearing capacity. Further, if the money is purely from the bank deposits or like wise products, they should restrict their equity exposure.
Equity exposure is required as to beat the infaltion and hence I would suggest balanced advantage fund category. In this category, the equity investments ranges from 30% to 80% depending upon the predetermined indicaors of the equity and debt markets. This products have the capacity to generate the returns which are better than the current 3 years bank fixed deposit rate, after considering the tax impact.
Still there is a product where in the equity exposure is in the range of 20 to 40% and naturally as the equity exposure is reduced it will reduced the return range and also reduce the volatility of the returns.
Still if the investor is having zero appetitie for the equity can choose the 100% debt product, which would be able to generate better than the bank fixed deposit interest rate after considering the tax impact.
Kindly note that I have high regards for all the mutual fund mentioned above. I am also suggesting the balance category schemes to the investors but after discussing the risk factors and the advanatages of the schemes. I bleive that all the schemes are good in nature and created keeping in ming a specific group of investors in mind. But there cannot be fit for all scheme!! The biggest challenge with all the stakeholders viz; mutual funds, distributors and investors should go hand in hand and understood think on perfect scheme as desired by the investor and investor muct control their GREED and FEAR both and it is the duty of the advisor to navigate the investor in his journey of investment till the achievemnt of his goal.