MF Query Board

Readers are requested to send only one query at a time so that more readers get a chance. Have questions relating to any aspect of personal finance. Ask DSIJ at editorial@DSIJ.in and get your queries resolved.

I am 65 years old retired individual. My Public Provident Fund (PPF) account is expected to mature on 12th December, 2019. Should I continue to stay invested in PPF or invest in mutual funds?

- Rasik Mehta

It is advisable to invest money in PPF as they are 100 per cent tax free. It is a kind of investing in a debt fund through Systematic Investment Plan (SIP), however, having a lock-in period. Nevertheless, it is always recommended that you should also invest a part of your savings/investible surplus in diversified equity mutual funds. Having said that, in your case if you don’t have investment in equity mutual funds then it is better to put some of the maturity amount in equity mutual funds. If you already have invested in equity mutual funds then you can go ahead with extending the PPF account for the next 5 years. The reason for extending this is that you would be able to earn returns that not just qualify for deduction under Section 80C of Income Tax Act, but also carry EEE (Exempt-Exempt-Exempt) tax profile. Wherein, your interest earned is tax free and the withdrawal at the time of maturity is tax free as well. However, it is equally important to have investment in equity mutual funds along with PPF, so that you would be able to beat the inflation. Being said that, it is highly recommended to hire a financial planner or a retirement planner who would not just help you to choose among various investment products based on your risk profile, but also chalk down your retirement cashflows.

I am a regular reader of your magazine especially the MF section. Based on the recommendations in the column, I have invested in Kotak Bluechip Fund, Parag Parikh Long Term Equity Fund and Kotak Standard Multi Cap Fund. I want to extend my portfolio and have exposure to debt funds as well. What are the things I need to look at before investing in debt funds?

- Piyush Dave

Diversification is key to have sustainable growth in wealth and I appreciate that you are thinking of diversifying your portfolio. Having a mix of debt and equity is advisable to de-risk your portfolio. To achieve this, you need to have a proper mix of assets based on your risk appetite and periodically rebalance your portfolio. Here are few things you need to check before investing in debt funds.

1. Exposure to low rated bonds : This is one of the things that investors must check in debt funds before investing. Low rated bonds have ratings below BBB and hence are risky. However, different rating agencies have different ratings. Credit risk funds usually have exposure to low rated bonds. Debt funds can invest in them with proper underwriting procedures to generate returns, but must not have high exposure to them.

2. Exposure to papers of one issuer : This is more sort of a diversification risk. As rightly said, “Don’t put all eggs in one basket”. This not only applies to stocks and equity funds but also to debt funds. Excessive exposure to papers of a single issuer or even a single group increases risk. Debt funds were severely affected by debt crisis of IL&FS, DHFL, Essel group, etc.

3. Lending against shares : This was also one of the issues that affects the debt funds. This happened specifically in Essel group case wherein shares were pledged against lending. The company needs to pledge shares worth 1.5 to 2 times of the lending amount If the value of shares pledged falls below the lending amount, the borrower has to pledge more shares to maintain the balance. In case of a failure, the lender (here, debt funds) can sell the shares in the market and recover the amount. However, funds with high exposure to such a setup may prove to be risky.

I am a retired individual and need regular income. Is it wise to put money in mutual funds with dividend option?

- Randeep Kamra

Dividend plans are something that people easily get carried away with. Mutual fund distributors or independent financial advisors aggressively sell mutual funds with dividend option to the investors who require regular income. This is because it is easier for them to convince people with such requirements. Earlier, dividends used to be tax free in the hands of investors and hence were considered a tax-efficient product which also generates steady income. However, the government introduced 10 per cent tax on dividends for all the equity mutual funds in the year 2018. Irrespective of the tax angle, dividend option does not seem to be a good option. Dividends are given out of profit accumulated by the fund over the years. Net asset value (NAV) of the fund reduces to that extent and hence compounding effect gets delayed over the long run. Further, paying dividend is at the sole discretion of the mutual fund house. If the fund is going through a downfall, they may not pay dividends. As the dividends are paid out of profits, NAV of the fund reduces to some extent and due to this over the long run, compounding effect also gets delayed. There is a better alternative to the dividend option: Systematic Withdrawal Plan (SWP). SWP allows investors to withdraw certain sum at regular intervals. This way investors are assured to get income at regular intervals unlike the dividend option, which is at the discretion of the fund house. Also, SWP does not affect NAV directly as in case of dividend option. However, you should note that short term capital gains tax of 15 per cent is applicable on monthly withdrawals. There is long term capital gains tax of 10 per cent on realization of gains above Rs.1 lakh.