Updated 25 April 2011: Given the popularity of the post I decided to redo the data until today and see how MIPs have fared. It seems that the data I had was off by a little bit (in terms of dividends, but the results don’t change too much). I’m reworking the entire post to include data till April 2011.
Mutual funds have monthly income plans – MIPs – that provide a monthly dividend; how do these compare against Fixed Deposits (FDs)?
First, note that MIPs are not risk free – they invest a little in equities as a “kicker”. So if you’re looking for ultra risk-free return, this is not it. I’m just looking at it as something that a retiree or semi-retiree can invest in, and doesn’t mind the slight additional equity risk. A lot of people I know would qualify.
Let’s take a 25 lakh investment made in an MIP – HDFC’s Long Term MIP Monthly Dividend plan is what I chose. Compare it with the same amount invested in a Fixed Deposit (FD) yielding 9% (Okay, no one gives 9% a year on FD monthly income, but let me be aggressive).
Taxation: Dividends on MIPs are tax-free; FD Interest is taxable. I’ve assumed a 20% tax. (Note, however, that about 13.6% of dividend distribution tax applies to mutual funds , including surcharge and cess, but this is paid by the mutual fund, not you. It reflects in the NAV.
Nowadays banks deduct 10-20% tax at source for FD interest – so if you get a lower tax rate you have to ask for a refund. That is crazy for someone who’s investing for a monthly income!
Returns: I plotted the four-year graph (assumed started on Jan 1,2007) of the entire return. The line graphs are the return-to-date for MIP and FD (including interest/dividend post tax) and the bars are the monthly income levels.
The return (blue and red lines) are the simple interest on the FD – since we require income, I assume no reinvestment of either the dividend or the FD interest.
The purple and green bars are the cash-flows every month.
Cash flows: The FD interest is constant, as expected (a net yield of 7.2%). The Monthly Income Plan has wayward income but you see the equity kicker give spiky income, but they seem to cap themselves at the lower end to what FDs would give.
The FD income, post tax, is about 15,000 per month, while the MIP dividend which is tax-free anyhow, is about 13,000 per month. However the difference is more than made up by the huge change in
MIPs seem to generate slightly higher income in parts – sorta like getting a bonus every once in a while.
|Current Value if Sold||27.65 lakhs||25 lakhs|
|Total Dividend/Interest Received
|7.78 lakhs||7.20 lakhs|
|Total Return||35.43 lakhs||32.20 lakhs|
The MIP has done well in the last four years – an effective yield of 7.70% versus 7.02% for the FD (this is assuming interest and dividends were not reinvested).
But the last one year has seen a flattening down, because the equity markets haven’t done too well and the long term debt market’s suffered on account of rising interest rates. Also FD rates are up to 10% now and interest rate slabs have been rejigged so your eventual tax liability with a 25 lakh deposit should be at 10% – that brings the FD return much closer to the MIP.
Liquidity wise: both the FD and MIP are liquid (you can get money out in a few days). The FD carries a penalty for early withdrawals though, and the HDFC MIP has a 1% exit load for the first year.
On the face of it, with the higher risk, the MIP seems like a useful option for someone with a large corpus and wants a higher monthly income. And lesser tax reporting hassles or refund issues.
Considering tightening liquidity in the markets and the fact that I expect equity markets to hurt with rising rates, I would expect the FD to outperform the MIP but only if you are in low interest rate slabs and looking primarily for income. If you are in a higher tax slab, then a short term debt fund is likely to do better (even a short term MIP) If you’re okay with keeping your money in for a year and then manually withdrawing money for cash flow each month, you could choose a growth plan and make higher returns because you don’t get that 13% dividend distribution tax hit.
Finally, if you’re already invested, moving to a different plan has a cost, that the new instrument will have a lock-in, work that out in your calculations before you move.
Note: Other options – tax free bonds that yield around 6.5% to 7.5%, Government 10 year bonds that yield a taxable 7.5% or corporate 10 year debentures that yield 10% or so. Some of these have monthly options too; and may be even better.