Liquid Mutual Funds vs Bank FDs

Liquid Mutual Funds are better than Bank FDs

Most of us generally have a good amount of money lying around in our various savings bank accounts, earning just about 4% per annum. This money may be part of our salary waiting to be spent, maturity amounts of insurance policies or FDs, redemptions from investments or any other credits received from elsewhere. We may not have any immediate plans to spend, invest or reinvest this money. When the money becomes available, we take our own time to plan its further use while it keeps lying in the savings bank account earning a low return.

But did you know that you can earn double the returns of a savings bank account while having almost the same level of safety, liquidity and ease of transaction?

Liquid funds – These are a class of mutual funds that have no exposure to stocks and invest only in debt (fixed income) instruments, generally with a residual maturity of less than 92 days. These investments are mostly in money market instruments, short-term corporate deposits and treasury bills.

Liquid funds provide good liquidity, low interest rate risk and also the prevailing market yield. Along with liquidity, the safety factor makes these funds a preferred parking option for HNIs and corporates as a good alternative to savings bank accounts and short-term fixed deposits. Most liquid schemes don’t have a lock-in period and offer redemption proceeds within 24 hours directly into your bank account.

All mutual funds have liquid schemes and try to provide the convenience of investments and redemptions in line with advancements in technology. You can invest in liquid funds through SMS, online banking, phone banking, call centre services and also physical applications. The same applies for redemptions also.

If it’s so easy and safe, why are these funds not so popular among common investors?
That is simply because of a lack of awareness. Mutual funds are generally associated with investments in stocks, while banks occupy a much larger part of retail investors’ consciousness than mutual funds do.

You should remember some important points while investing in liquid funds. These are essentially short-term investments. If you keep your money here for too long, typically more than a year, you may lose out on better opportunities elsewhere. Another advantage of liquid funds is that if you think your money is likely to be lying around for a longer time than thought initially, you can seamlessly shift it to longer duration debt mutual funds or even equity funds without much hassle.

On the issue of taxation, even with part-redemptions from a liquid fund within a year, the gains will be taxed according to your income tax slab. Beyond a year, the gains get the benefit of indexation as a long-term gain. You can invest in growth, dividend and dividend reinvestment options. Dividends paid by these funds are tax-free in your hands. Liquid funds also score over bank deposits because they do not deduct tax at source (TDS).

Investors who tend to keep a sizeable balance in their savings bank accounts, and that too for a long period, may look at investing in liquid funds to enhance returns. It can make an appreciable difference to what you get to keep in the end.

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Mutual Fund Risks

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Understanding risk in mutual funds

Risk is inherent to investing. Investments vary across the risk spectrum, but there is hardly any investment that’s entirely risk-free. Mutual funds also carry risk. But first, what is ‘risk’? In the world of investments, risk is the other name for volatility or fluctuation in price. An investment that is susceptible to wild swings in either direction is considered to be highly risky. Both equity funds and debt funds carry risk. Comparatively, debt funds are generally not as risky as equity funds. Equity tends to be volatile, especially in the short to medium term.

In order to judge the inherent risk in mutual funds, the most basic tool is the riskometer. All mutual fund schemes carry a riskometer which points at the inherent risk in the scheme. The figure alongside shows a mutual fund riskometer.

More specifically, here is how various equity funds stand in the increasing order of their risk grade:

Understanding risk in mutual funds

Balanced funds are the least risky as they can invest as much as 35 per cent of their assets in debt. Since large companies don’t fluctuate wildly, they come next. Mid and small caps are notorious for their crazy moves, so the funds investing in them appear at the second-last position. Finally, since thematic and sectoral funds take highly theme-specific bets, they are the riskiest of all.

Here is how debt funds stand in the increasing order of their risk grade:

Liquid funds < Ultra short-term funds < Short-term funds < Income funds, credit-opportunities funds, dynamic-bond funds, long-term gilt funds

With debt funds, the risks are two fold: interest risk and credit risk.

Interest risk means that interest rates may move up or down unexpectedly. A rise in interest rates results in a decline in bond prices and vice-versa. So, a fund that holds long-duration bonds is subject to high risk.

Credit risk is the risk of default by the bond issuer. Debt funds that invest in relatively lower-rated paper carry this risk.

There are other risks also in mutual funds, which the investor can minimise by making prudent decisions. By investing across multiple fund houses and schemes, one can reduce the fund-house-specific, fund-manager specific and scheme-specific risk. Also, by sticking to multi-cap equity funds one can reduce the portfolio risk.

SIPs are Best Investments when Stock Market is high volatile. Invest in Best Mutual Fund SIPs and get good returns over a period of time. Know Top SIP Funds to Invest Save Tax Get Rich – Best ELSS Funds

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Calculate RETIREMENT Amount

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An ideal retirement corpus should take care of all your expenses after you stop working. But can you calculate the amount required? It involves taking into account life expectancy, interest rates, inflation and the time value of money…and can be a bit tricky. Here we explain how to use MS Excel to calculate the amount easily. But first, let’s understand some basics.

The concept of time value of money states that the worth of a rupee received today is more than a rupee received at a later date because of its earning potential. The concept of time value has two elements: Compounding and discounting. Compounding helps to estimate future values whereas discounting helps to estimate present values. For calculating your retirement corpus, it is the present value that matters.

For example, an investment product promises ₹8 lakh in 10 years if you invest ₹4 lakh today. Given interest or term deposit rates of 8% per annum, will this investment product be profitable? You will have to find out the present value of ₹8 lakh at 8% discount rate to arrive at the right answer. Present value is calculated by dividing ₹8 lakh by (1+r) ^n, where ‘r’ is the discount rate (or interest rate) and ‘n’ is the tenure of investment. The present value of ₹8 lakh works out to be ₹3.7 lakh.

Since the present value of the amount that the product promises to pay (fund inflow) is less than the amount invested (fund outflow), the product is not profitable. In other words, the net present value of the investment product is negative. Net present value is the difference between the present value of cash inflows and present value of cash outflows.

If the same ₹4 lakh is invested in an FD for 10 years, offering 8% annual interest, the maturity proceeds work out to be ₹8.63 lakh (assuming no tax)—₹63,000 higher than the aforementioned investment product.

Calculating the present value of an amount gets complicated, if the investment generates a series of payments over a period of time. To calculate the current worth of such an investment, the present value of each payment in the entire series of payments needs to be derived. Technically, one needs to find out the present value of an annuity.

Estimating one’s retirement corpus involves calculating the present value of an annuity. This is because, one expects to generate a stream of payments—monthly, quarterly or annually—from one’s retirement corpus for a given number of years at a certain rate. Such stream of payments seek to take care of one’s post-retirement expenses—based on one’s current expenses and assumed inflation rate.

A 38-year-old with current annual expense of ₹6 lakh can calculate his annual expenditure requirements when she retires at the age of 60, based on an assumed annual inflation rate over 22 years (the period after which she will retire).

For instance, at 5% assumed inflation she will need ₹17.5 lakh—₹6 lakh x (1+5%)^22. The ideal retirement corpus must generate a stream of ₹17.5 lakh annually for 25 years after retirement, assuming life expectancy of 85 years. Such a corpus can be arrived at by adding the present value of each stream of ₹17.5 lakh discounted at an appropriate rate. The appropriate rate is generally the average long-term (10-year) yield on government securities. Additionally, the post-retirement inflation also needs to be taken into account.

Although the methodology appears complex, MS Excel’s NPV function can help you do the calculations easily. NPV requires you to input the discount (or interest) rate and the series of expected inflows or estimated expenses.

At 7% discount rate and assuming no inflation, the present value of the annuity works out to be ₹2.04 crore. So, in our example, the working professional will have to accumulate ₹2.04 crore for his retirement. However, if we assume post-retirement inflation of 4.5% per annum, he will have to accumulate ₹3.12 crore. One can play with the numbers to see how changes in inflation, discount or interest rates changes the desired corpus.

SIPs are Best Investments as Stock Market s are move up and down. Volatile is your best friend in making Money and creating enormous Wealth, If you have patience and long term Investing orientation. Invest in Best SIP Mutual Funds and get good returns over a period of time. Know which are the Top SIP Funds to Invest Save Tax Get Rich – Best ELSS Funds

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Invest in Mutual Fund MIPs for higher Returns

MONTHLY INCOME PLANS V/ S POST OFFICE SCHEMES

Investors looking for a regular monthly income can choose between Monthly Income Plans (MIPs) offered by mutual fund houses or Post Offices. Both have their own advantages and disadvantages.

While the former can offer higher returns, since they invest in market linked instruments, the latter is safer since it is guaranteed by the government. The Post Office schemes are very easy to invest in, due to which they are preferred by retired people. But MIPs are more tax efficient and hence, suitable for High Networth Individuals ( HNIs) Investors should invest in MIP or Post Office Monthly Income Schemes ( POMIS) based on their risk appetite. While MIPs can offer higher returns as compared to POMIS; it also carries market risk and interest risk. On the contrary POMIS provide guaranteed monthly income, but do not meet the inflation ‘ risk’.

MIPs

MIPs are open- ended schemes that invest a majority of their assets in fixed income instruments and allocate asmall portion to equity and equity- related instruments. MIPs typically invest in debt instruments like debentures, corporate bonds, government securities and so on, while maintaining a small exposure to equity to earn something extra.

Generally, the equity allocation is maintained between 10 per cent to 25 per cent of the total assets. This is a good option for those investors who are looking at regular and steady income and still want to dabble a bit in equities.

Like all other mutual funds, MIPs too come with the growth and dividend ( Payout and Reinvestment) option. The growth option of an MIP is ideal for a ‘moderate’ risk profile, since it typically falls between a pure income fund and a balanced fund. It is a viable option for HNIs, institutions, trusts and so on, as these investors typically do not require a regular monthly dividend inflow, but still would like capital appreciation at controlled risk levels.

Investors can invest in such funds if they are conservative in their investing style and are looking out for better returns or are looking for a regular source of income. Also, this is suitable for investors in the high tax bracket, since it is more tax efficient than options like fixed deposits and post office monthly income schemes.

MIPs offer an investor regular income through the ‘ dividend’ option. Since they invest in debt instruments, whenever the interest rate falls, the capital gain on bonds rises as price of bond increases and when interest rate raises, capital gain on bond falls.

Taxation of MIP’s

MIPs are treated as debt funds and, hence, the taxation is same as debt funds. Dividends are exempted from tax in the hands of investors, since company pays a Dividend Distribution Tax on such dividend declared.

Redemption is covered by capital gains tax based on the holding period tenure.

Short- term capital gain – if the holding period is less than one year, the capital gain will be considered as a short term capital gain. It will be taxed as per tax slab Long- term capital gain – if the holding period is more than one year, the capital gain will be considered as a long term capital gain. It will be taxed either 10 per cent without indexation or 20 per cent with indexation.

Long- and short- term capital

loss – The good part of MIP is that any short term gains made on MIPs can be set off against short term losses. And long term capital gain on MIPs can be set off against long term losses.

Post Office Monthly Income

Scheme ( POMIS) is a guaranteed return investment available at the post office. On the deposit made in the post office, monthly assured return in the form of interest is earned. Though it offers no tax incentive, it is a preferred instrument amongst small savers because of its government backing that the product offers. However, there is an upper limit for investment into POMIS. You cannot invest more than ₹ 4.5 lakh in asingle account. If you invest jointly, the limit is ₹ 9 lakh. The minimum investment is ₹ 1,500.

Features of POMIS

The capital invested in POMIS is completely protected as the scheme is backed by the Government of India, making it totally risk- free with guaranteed returns. The amount invested is liquid, despite the fact that there is asix- year lock in period. However, the biggest disadvantage of POMIS is that it is not inflation protected, which means that if the inflation is the same as interest rate, then there is no real rate of returns.

Taxation of POMIS – It is taxed along with the regular source of income. However, Tax Deduction at Source is not applicable.

In a falling interest rate regime, monthly income plans will score over post office schemes due to equity exposure

Risk Low risk No risk involved as it is government backed Range of returns 6 per cent to 12 per cent p. a. 8% p. a

Complexity Moderate Simple to understand and invest Assured monthly income Not really assured Assured monthly income Penalty for early 1 per cent before 1 year 2 per cent before 3 years; 1 per cent after withdrawal 3 years and before 6 years Tax on returns Dividends are exempted in Interest income is taxable the hands of investor; as per the tax slab redemptions are taxable as per capital gains guidelines Limit on investment No limit ₹ 4.5 lakh for single account and ₹ 9 lakh for joint

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