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MIPs Are Not Risk-free

In view of the low interest rates offered by the post office, is it advisable to invest in a MIP. I am looking at 12 to 13% returns, but can't stomach high risk. Please suggest to me a fund and when to invest and withdraw.

After retirement, my father has invested his savings in the post office. In view of the low interest rates offered by the post office or for that matter banks, I suggested that he invest a very small portion of his savings in mutual funds. On the suggestion of a friend, I asked him to opt for the HDFC MIP. We are looking at 12 to 13 per cent rate of return but can't stomach high risk. I would like the money to grow as I receive the dividend. Please suggest to me a fund and when to invest and withdraw. Also tell us about the income tax on these investments and the dividend.
Prabhakar Ramesh Joshi

Monthly income plans would be one of the best ways to achieve the objectives, which you have set for yourself. But before you plunge into it, it's important to consider a few things. All mutual fund schemes are subject to market risk and monthly income plans are no exception. With an equity component of up to 25 per cent, these funds are capable of delivering a capital loss. Also, there is no guarantee on the quantum and frequency of dividend payouts.

You have mentioned that you would like your investment to grow as you receive dividends. This will not be possible as dividends come from the profits that the fund generates. If you want your investments to grow you should opt for the growth option where you will not receive any dividends.

The fund you have selected—HDFC MIP—is a new scheme. It was launched in December 2003 and therefore does not have a long performance track record. We believe that a fund should be around for at least three years so that it has witnessed different market cycles and a call can be taken whether it is worth investing in. But this should not worry you as there a good number of monthly income funds to chose from.

Regarding the period of investments, it would be advisable to stay invested for a period of at least three years. Once you have decided on the amount to invest, you can enter through an SIP (systematic investment plan) so that your investment is spread over time. The time of exit depends on you. If you feel that you have generated the desired level of returns and you need the money then you can withdraw. As these are open-end funds, you can redeem your investments at any time.

Short-term capital gains from mutual funds are taxed at the marginal rate. Long-term capital gains are taxed at the rate of 20 per cent, with indexation benefits or 10 per cent without indexation benefits, whichever of the two is more favourable. If you are interested in regular payouts, then we would recommend the systematic withdrawal route. Assuming that you are in the highest tax bracket the tax liability in case of an SWP works out to 1.39 per cent. This happen as in the initial years, the gain component is very small. As compared to this, receiving dividends is subject to a 12.81 per cent dividend distribution tax.

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