Monday, November 17, 2014

SWP in a mutual fund - a better option for regular income

My article in Mumbai Mid-day Gujarati edition today:

English translation of the same is as under:

In the last two columns, we have highlighted some points about how mutual funds make it convenient to attain some of our objectives. First we talked about someone who has a regular savings that one needs to invest to achieve long term goals – mutual funds offer a facility called SIP for this. Then we looked at how convenient mutual funds make to buy gold. Let us now look at another category of investors, who need regular income from the investment portfolio.
Such an investor typically looks at certain traditional instruments that offer regular interest income – Post Office Monthly Income Scheme (MIS), Senior Citizens’ Savings Scheme, Fixed deposits, Debentures are some of the options that come to mind. All these are good investment options, but each has certain limitations. Due to these limitations, these instruments may be suitable to only certain investors and only in certain situations.
Let us spend some time in these instruments. All the abovementioned instruments give a feel of safety. However, the level of safety could be very different among all these. The Post Office MIS and Senior Citizens’ Savings Scheme are much safer than debentures issued by companies. Fixed deposits issued by banks are much safer than those issued by Non-Banking Finance Companies (NBFCs). An investor must keep this in mind.
Two features of these instruments must be understood properly. These are: term and interest rate. All the traditional instruments listed above have a fixed term and a fixed interest rate. That gives a good feeling of safety and regularity. However, if we consider the needs of a typical investor and compare the same with the features of these instruments, we start seeing a gap.
·      First of all, the investor may need regular income for a period that is different from the term of these instruments. We may have a five-year debenture available in the market. What if the investor needs regular income for seven years or three years? What about a retired investor, who would need regular income till one is alive and that period is unknown.
·      Secondly, all these instruments have a fixed interest rate. If we consider a retired investor, the income from investments is required to fund regular household expenses. These household expenses do not remain constant – they go up over a period due to the rise in prices of essential items like food or medicines.
Given these two gaps, the traditional instruments, though safe and predictable, may not be suitable to all in all situations.
Hence, there is a need to look at alternatives, if available. One such alternative is offered by the mutual funds. This comes in form of Systematic Withdrawal Plans (SWPs).
How does SWP work?
All mutual funds offer facilities for systematic transactions. An investor is required to give standing instructions to the fund house and they take care of completing the transaction based on the instructions given. SIP is one example of such standing instruction or systematic transaction.
Any investor can invest a lump sum amount in a mutual fund scheme and give standing instruction to the fund house for regular withdrawal of a fixed amount. Let us say, one needs regular income of Rs. 5,000 per month and has a sum of Rs. 5,00,000 that can be invested. After investing the amount in a particular mutual fund scheme, the investor needs to fill up a form for SWP. Every month on the stipulated date, the money would be taken out of the scheme and paid out to the investor.
This small amount withdrawal can be set up irrespective of the gains generated by the scheme. This is possible due to the divisibility of the investment. Though one can withdraw any amount (as long as it is less than the balance in the account), one would recommend keeping the withdrawal rate closer to (preferably lower than) the expected rate of investment growth. If you are expecting the fund to grow at 10@ p.a., keep the withdrawal rate at less than 10% p.a.
At the same time, if one has a need for regular income only for a stipulated period, say 5 years, one can draw the full amount over these 5 years.
SWP is much more tax-efficient than earning interest income from fixed income investments, if the withdrawal is done for a very long period. As compared to traditional instruments, this does not need the full amount to be blocked for the entire period, which means, one can keep withdrawing regularly and keep funding the account whenever other investments mature or when other lump sum amount is available.
A word of caution: please consider this discussion only in the context of liquid and short-term debt funds and no other categories.
Amit Trivedi
The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.

Monday, November 3, 2014

Buying gold is more convenient now

My article in Mid-day Gujarati's Mumbai edition today:

Click here to read ...

The English translation is as under:

The festival days are here. This is the season of buying Gold in many Indian families. Buying gold for investment purposes was highly inconvenient at some point in time, as the laws did not allow one to buy gold in any for other than jewelry. Today, it has become very convenient to invest in gold.
Buying physical gold has its own limitations.
Most of us cannot make out the difference between 18 carat gold and 24 carat gold. The price difference could be very high between the two. We can buy certified gold, as that facility is available now. However, this facility comes with a price. Any additional price paid reduces the future returns from the investment.
Physical gold also needs to be stored properly, as the precious metal suffers from the risk of theft.
Physical gold has to be added to one’s wealth for the purpose of calculating wealth tax. Thus, if the total wealth exceeds the minimum cut-off limit, one would be required to pay wealth tax irrespective of whether one is earning on the same or not. A tax outflow is an expense and it brings down the return on investment.
A recent innovation has taken care of the above limitations. (Although, this is a decade old innovation, many do not know about it). This innovation is known as Gold ETF – a mutual fund scheme that allows one to participate in the growth of price of gold. It is a financial instrument through which one can reap the benefit of investing in gold.
Gold ETFs are mutual fund schemes that invest in physical gold and issue units against these to the scheme’s unitholders. The gold is stored with a SEBI registered custodian. Periodic audits are carried out to ensure that for each unit of Gold ETF, there is an equivalent quantity of gold available with the custodian. The NAV of the unit varies in line with the price of gold in wholesale commodities market. The unit of a mutual fund is defined as “security” and hence is exempt from wealth tax. Since the gold is stored with a custodian and the investor only holds demat units, the risk of theft is eliminated.
These units can be bought through the stock exchanges with the help of member brokers. One needs to have a demat account for this purpose as the units purchased through stock exchanges are delivered only in demat format.
The mutual fund companies innovated further and introduced another category of mutual fund schemes that allows an investor to hold the units through an account statement without the need for a demat account. These are popularly known as gold savings funds.
Take advantage of these innovations to accumulate units of gold.
With you all a very Happy Diwali and a Prosperous New Year!
Note: This article is not about whether gold is a good or a bad investment. It is about a new and convenient way of investing in gold. At the same time, it is important for one to understand why one is buying gold.

Amit Trivedi
The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.