Q. I want to set aside ₹5000 every month for medical expenses that might be required in future. I intend to invest this amount in monthly income plan (growth option) mutual funds rather than recurring deposits or FDs. Is this the right decision? What is the difference between this fund and a debt-oriented conservative fund?
A monthly income plan (MIP) is a type of mutual fund investment that focuses on debt or a combination of debt and equity securities with the goal of generating cash flows while preserving capital. Following the SEBI classification a few years ago, this category is also known as a conservative hybrid/debt fund and is subject to debt taxation.
Income Distribution cum Capital Withdrawal (IDCW) schemes are those that distribute income that may include both dividends paid by stocks and capital gains made by selling some underlying stocks from the scheme’s portfolio. Many investors consider IDCW funds as a reliable source of income. Instead of reinvesting the money or profit from your mutual fund assets, you choose to receive it on a regular basis, say once a month. As against this dividend option, if you opt for the growth option, it reinvests the returns or profits in the fund.
However, dividends are not a consistent source of income. Dividends are declared only when a scheme has generated distributable surplus or profits, which may not happen regularly.
MIPs do not offer guaranteed returns. An MIP can only declare dividends if it earns money from interest, dividends, and trading. If the MIP loses money, there will be no money to distribute to the investors.
If you require a regular income, you might want to consider the systematic withdrawal option (SWP). This does not entail any tax deduction and both the amount and frequency of withdrawals can be fixed by the investor. It is prudent to start withdrawals after about 9 months of investment, to ensure that you do not end up withdrawing capital.
To meet medical emergencies, you should invest in a fund that will be less susceptible to market fluctuations. Depending on the timeframe, certain debt mutual fund types (such as ultra-short duration, low duration, liquid funds, and short duration funds) offer a conservative approach and fit your requirement. You may invest in one such category and opt for an SWP.
You may not want to invest in long-duration mutual funds because these are significantly affected by changes in interest rates and may not be the best option to meet unexpected medical emergencies.
As your fund requirements are likely to be sporadic, it is best to select the growth option. These usually do not have a lock-in period and can be easily liquidated when required.
Fund selection criteria
All papers under the scheme should be of high quality or AAA rated - Papers are underlying debt instruments in the fund’s portfolio. AAA rating is considered the highest credit rating assigned to a borrower's ability to repay debt. It represents a very low credit risk and is often considered a benchmark for determining the creditworthiness of a borrower.
Low expense ratio (the lower the better) - Expense ratio of a fund is the annual fee that fund’s investors pay to cover the operating costs of running the fund. It is expressed as a percentage of the fund's assets and is deducted from the fund's net asset value. The expense ratio includes various costs such as management fees, administrative expenses, and other operational costs. The expense ratio is an important factor to consider when choosing a fund because it can have a significant impact on the fund's performance and overall returns.
Yield to maturity ratio should be high (the higher the better) - Yield to maturity (YTM) is a financial metric that represents the total return expected on a bond if the bond is held until it matures. It considers both the coupon payments (interest payments) and the potential capital gain or loss from buying the bond at a discount or premium to its face value.
Yield to maturity is often used as a benchmark for the expected return on a bond investment. The yield to maturity calculation considers the time value of money and considers the bond's coupon rate, current market price, face value, and time to maturity. It provides an estimate of the average annual return that an investor can expect to receive if they hold the bond until maturity.
Yield to maturity is an important factor for bond investors as it can help them compare the expected return of different bonds and make informed investment decisions. However, it is important to note that the actual return may differ from the yield to maturity due to changes in the bond's market price and interest rates.
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