Fund Talk

I am 29 years old. I have invested 20 per cent of my savings in equity markets, 5 per cent in Gold Exchange Traded Funds and 50 per cent in fixed deposits, while the remaining is idle. Apart from these, I have recently started investing Rs.1000 monthly in Franklin India Bluechip Fund, Birla Sun Life Dividend Yield Plus and HDFC Prudence. Also I have been investing Rs.1000 monthly in HDFC Tax saver from April 2010. I am planning to buy a flat by end of 2012 or beginning of 2013. I want to park my ideal amount and another 1 year's savings in a safe place so that my capital is not eroded. I do not want to invest in fixed deposits as returns after tax and inflation makes them less attractive. Is it safe to invest in liquid funds? Let me know if the above mutual funds are good funds.

Krishnakumar

It is good to note that you have begun your investments with an asset allocation plan, something that most investors don't do. Apart from buying a home, you have not specified the other goals towards which you are currently saving. Assuming it is for ten-year plus goals like retirement, however, there are two shortcomings in your asset allocation.

One, the equity allocation may be too low to allow your investments to beat inflation. Given that age is on your side, we would suggest raising your overall equity allocation to 40 per cent, probably by putting a higher proportion of your future savings into SIPs (systematic investment plans). The four funds you mention are reasonable choices. However, we would recommend an open end fund such as HDFC Top 200 over the HDFC Taxsaver for regular investments. Not only does the former have a superior track record, the tax benefits on equity linked savings schemes may be removed when the new Direct Tax Code is implemented next year.

You can add in additional SIPs on Franklin India Bluechip, HDFC Top 200, Birla Dividend Yield Plus and HDFC Prudence. As actively managed equity funds can underperform markets at times, we would also suggest adding a fund like the Benchmark S&P 500 Fund to reduce risks.

Options to park idle money

Second, you seem to be idling rather a large portion — 25 per cent — of your portfolio. This may entail a large opportunity loss and will pull down your overall return over the long term. Yes, fixed income options such as bank deposits may not offer a great inflation-adjusted return. But the return they offer now is still better than what you earn on your savings account.

From your query we presume that you are holding idle money in order to fund the down payment on your home when you purchase it in 2012 or 2013. We are assuming that much of your cost of purchase of property will be funded through a bank loan. Your equity investments will not be of much help here, as it would be quite inadvisable to park any funds required over the next three years in equity funds.

As you may need this money anytime after a year, it is best to park it in open end debt funds with a focus on short term debt. Liquid funds and short-term income funds appear to be the best option. Both have managed a 8.4 per cent return in the last one year on an average.

Liquidity vs returns

However this is a function of tight liquidity in the market and rising interest rates. If rates peak out soon, as expected, these funds may yield you lower returns than currently, say 6-7 per cent. Your point that this won't beat inflation is valid. But if liquidity at any time is your priority you will have to make a sacrifice on returns.

Yes, liquid funds are more tax-efficient instruments compared to bank deposits. While interest on bank deposits will be taxed at your slab rate, long term capital gains on liquid funds are taxed at 20 per cent (with indexation) or at 10 per cent (without it), for holdings greater than one year.

If you opt for the dividend option, the fund will pay out dividends after deducting a dividend distribution tax of 22.6 per cent. If you are in the 30 per cent tax slab, either option will work out to a lower effective tax on returns than bank deposits. However, do note that liquid fund returns are not fixed like those from bank deposits.

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