Mutual Funds

Fund Talk

AARATI KRISHNAN | Updated on February 26, 2011

fund

I am a regular reader of your column ‘Fund Talk'. I am 38 years old and work as a manager in an MNC drawing a monthly salary of Rs 30,000. I started investing in HDFC Monthly Income Plan - Long Term - Growth through the systematic investing route at the rate of Rs 5,000 per month. The whole idea behind this was that I need to have Rs 60,000 to pay my annual LIC premium (endowment policy for 20 years) at the end of each year. I thought it is better to accumulate through SIP rather than a recurring deposit with a post-office or a bank, as this would fetch me higher returns than a recurring deposit. Is this is a wise thing to do?

Balaji

Though the fund you have chosen is a good one within its category, your idea of using it to accumulate money for your annual insurance premium isn't a great one. Liquid funds or short-term debt funds may be a far better option if your idea is to park money for a year or less.

Sub-optimal returns

We say this because monthly income plans from mutual funds have an equity component and holding on to them for a 3-4 year time frame is essential to make reasonable returns from them. If you plan to withdraw sums from the fund every year, chances are that your returns from the fund will be sub-optimal, at least in some years. That's because, during years when the stock markets decline or stay flat, the returns from this fund too may fall or even move into negative territory.

HDFC MIP Long Term Fund in fact, has delivered positive returns in four of the past five years. However, the fund's NAV actually declined by over 8 per cent in 2008, a bearish year for stocks market. Given that you will have to withdraw money from the fund every year, you will not be in a position to wait out periods of high volatility in the stock market.

We recommend switching to HDFC Hi Interest Short Term (three-year returns of about 8.6 per cent per annum) or HDFC Liquid (3-year returns of 6.8 per cent per annum), if parking money of the short term is your intention.

SIPs better for equity

You mention that you are using a systematic investing plan (SIP) to save this money, which means that your effective returns from this MIP fund may be even lower. This is because the sums you invest in the fund may not stay invested even for one year at a time. SIPs tend to enhance your return from a pure equity or equity oriented funds mainly because they help you avoid the risks of poor timing. If the equity market corrects after you have begun investing, your subsequent investments can be made at lower stock prices, thus helping up your returns. As debt funds usually earn their returns consistently through the year, SIP investing will only lower the effective returns you get from them.

Since you appear to be a returns-conscious investor, you should also re-evaluate your decision to invest as much as Rs 60,000 a year in an endowment plan. Such traditional insurance plans usually manage returns of 6-7 per cent a year at a maximum, which may barely match inflation, especially as inflation is likely to remain at elevated levels from here on.

If securing risk cover against your life is your goal, you can do that through a pure term insurance policy that will come to you at much lower levels of annual premium. If you are looking to build a corpus towards a long-term financial goal and can assume a degree of risk, we would suggest using the systematic investing route in a balanced or hybrid fund (HDFC Prudence or Templeton India Pension Plan respectively) to do this. These funds may manage annual returns of 15 per cent and 10-12 per cent respectively, if you manage to remain invested for a 10 or 15 year period.

Even for completely risk-averse investors, the recent increases in interest rates have made safer long-term options available. The recently launched SBI Retail Bond offer with 10-year coupon rates of 9.75 per cent is an attractive option. Rising phases in the interest rate cycle do not occur all that often. So do keep an eye out for such options and actively lock into them for the long term.

Published on February 26, 2011

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