Monthly Income Plans Versus Fixed Deposit

13 comments Written on April 25th, 2011 by
Categories: FixedIncome, MutualFunds

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)?

Risk-Free?

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.

Example

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.

Monthly Income Plans versus FDs

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.

Concept MIP Fixed Deposit
Current Value if Sold 27.65 lakhs 25 lakhs
Total Dividend/Interest Received
(Post Tax)
7.78 lakhs 7.20 lakhs
Total Return 35.43 lakhs 32.20 lakhs

 

Verdict?

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.

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About the Author:
http://www.capitalmind.in
The man behind Capital Mind. Deepak is a co-founder at MarketVision, a financial knowledge company. Deepak also provides data research and consulting services, and now lives in Bangalore. Connect with him at deepakshenoy@gmail.com.

13 comments “Monthly Income Plans Versus Fixed Deposit”

>Deepak some confusion.
you said income from MIP will be TDS'd by bank
then how come it has

"And lesser tax reporting hassles or refund issues"

or am I missing something here?
Thank you

>I think the MIP fund has to pay distribution tax of ~15% whereas that's not the case for equity fund dividends?
http://www.itrust.in/content/mutual-funds/mutual-funds-and-taxes-in-india

Do you know if this is the case and does your comparison with FD include that tax?

Thanks,

>Deepak… Do consider Post Office monthly Income Scheme which yields 8% interest & also give 5% bonus on maturity (5% of deposit)

Thanks…

>Siddharth: Banks deduct tax for FDs, not MIPs, sorry – corrected.

Lukkha: the NAV is net of the dividend distribution tax, so it has been included.

>Hi Deepak Sir..

Please look at Post office monthly income scheme also

It gives 8% interest and also gives 5% bonus on deposit(6 year Maturity)

http://www.indiapost.gov.in/Netscape/6yearsMIS.html

>Hi Deepak

Post office provides 9% interest
upto 15 Lakhs for senior citizens.

This safe and without risks

>Hi , Deepaksir

How to identify better return scheme with
common principal amount / year of maturity
between nos of MIP / various FD/ Mutual funds / postal bonds / Banks recurring schmes.

- Mayurbhai Prajapati – Dhanera

>For someone in 30% tax bracket MIP will be even more attractive as it is tax free in investor's hand while bank fd is taxable.
-P M Narendra

>Hi Deepak,
My dad has put in money in MIPs – HSBC and Birla Sunlife. Though HSBC provides more money per month, the actual value of the MIP is getting lower, so the effective gain is much lesser (4% vs 7% for HSBC and Birla rly). So seems like you cant just look at the returns(monthly payments) only. Do you know of a metric which can be used to calculate risk/return for an MIP ? Is there an equivalent of a Beta ?

>Could you help me with a complete idea regarding MIPs. I am really new to the field, but would like to know more about it…I am doing a bit of reading on the same…

>hi Deepak ..

AXIS bank for a senior citizen is giving 10.25% interest on FD

Also I believe Post Office MIP is good! do compare

You have compared only Mutual fund MIPs with Bank FDs. MIPs provided by other institutions like banks, insurance include interest payouts just as those Bank FDs.

Well said & absolutely true..But Bank FD’s dont provide the better returns in compared to Post income as said by Umag in the given link.