A contingency fund ensures that an unforeseen event do not upset your financial health considerably
28-Oct-2015 •Research Desk
I propose to invest in Birla Sun Life Dynamic Bond Fund or Birla Sun Life Cash Plus to keep a reserve of six month's salary as an emergency fund. Should I opt for growth scheme or dividend reinvestment or dividend payout? Kindly Advise.
- Kolappa Pillai
A contingency fund ensures that an unforeseen event do not upset your financial health considerably. The corpus should be enough to cover the living expense of three to six months. It should also kept in a liquid investment avenue like bank deposit and liquid funds. One can keep 50 per cent of the corpus in a bank deposit that can be broken easily. The other half can be kept in a liquid fund where you would get the money in a day's notice. Birla Sun Life Dynamic Fund is not suited for this purpose, you can park the money in Birla Sun Life Cash Plus.
If you are in the lower tax bracket of 10 per cent or 20 per cent, it may make sense to go for the growth option. This is because the applicable income tax rate (10.3 per cent or 20.6 per cent) on short-term capital gains is much lower than the dividend distribution tax (DDT) of 28.84 per cent mutual funds pay on declared dividends. However, if you are in the highest tax bracket of 30 per cent, you may earn a little more by opting for the dividend option because of the marginal difference in tax rates (28.84 per cent DDT vs 30.9 per cent applicable income tax slab). If you are in the highest tax bracket and don't want periodic income from your investment, you can opt for the dividend reinvestment option. This method would result in nil or almost nil capital gains on your investment. However, you would earn only a little extra here as mutual funds would be paying DDT on dividends declared.
Short-term capital gains tax on debt funds are added to the income and taxed as per the applicable income tax slab of the investor. If investments are sold after three years, returns will qualify for long-term capital gains tax of 20 per cent with indexation benefit.