Are FDs and Life Insurances the Only Way to Invest ?
I am happy to be proven wrong, but ask any person on the street for their investments (ignore Insurance agents please !) and they are most likely to say that they invest in Fixed Deposits or similar products like NSCs, PPF, KVPs, Post Office / Bank MIPs, RDs, AND LIC / Insurance policies. It would feel so nice that you are not doing anything wrong as almost every one on the street is investing in the same manner and products as you are. But have you ever challenged the system to ask if there are any other alternative products which could give you better than similar kind of returns which you get from these investment products ? One good investment product to your disposal can be Monthly Income Plans (MIP) offered by many fund houses.
Before we go into details of a MIP, let me first point out what makes FDs an interesting product for the masses ? Lets see them very briefly.
1. Certainity – At the time of investing into a FD you know clearly when you can get your money back and HOW MUCH will you get.
2. Capital Safety – You can sleep peacefully as your money is safely parked with a bank you can trust. And it will only go in one direction – that is increase by a set pace.
3. No Volatility – For those who hate roller coasters and volatility, FDs seems like a safe haeven. You know that the graph of your FD value will go steadily north.
Lets analyse each of these characteristics as their definition is too subjective.
Now that makes me really ponder as to what people consider as certain. Is it certain enough to know that you will get 10268.87 INR for your Rs. 5,000 INR in x years ? Every thing has a value. What needs to be understood is the cost you are paying to get that comfort of certainity. I can bet that a person would be comfortable if the future value of his investments is materially within his comfort thresholds, if this comes with an opportunity to enhance the returns. For example, if you are getting fixed 9% return for a 5 year FD and you get an opportunity to enhance this return to 11-12% with a downside limited to around 6%, would you still want to say it a ‘No-No’ ? Or would you give it a consideration as the returns can fluctuate between 6 %- 12% ? I would personally want to understand a bit more around such products whose returns have a potential to earn more than FDs with a limited downside.
Again, what is the definition of capital safety – you need your principal amount back – isn’t it ? That safety comes from the credibility of the the bank with whom you are placing your FD. You may be surprised, but international community do not regard our banks as safe enough ! To make it technical, the most safe asset should get a ‘AAA’ rating. Lesser ratings are ‘AA’, ‘A’, ‘BBB’, ‘BB’, ‘B’ and a few more. Generally the bank FD’s get a rating of AAA reflecting that the investment is of very high quality with negligible risk of default. So in light of above, if you get another asset with the same rating, would you be open to classify as safe ? In my opinion any rating in the ‘AAA’, ‘AA’ or ‘A’ territory has low level of credit risk.
Oh dear ! This one really makes me laugh. People just don’t want volatility in their investments. They just prefer 5K, 5.1K, 5.2K and so on. They won’t like the value of their investments to look like -> 5K, 4.9K, 5.2K, 5.1K, 5K, 5.4K – reason – perhaps makes them uncomfortable that this could result in possible ‘0’ as well ! Even the safest assets known to mankind or rather Indian man kind ‘Gold’ and ‘Government of India’s Bonds’ fluctuate like heart beat. But if held for long term, there is close to zero volatility. Hence to summarise, investments may look volatile in short term, but if looked from a long term perspective (say 5 year like a 5 year FD), they have a low or no volatility.
Take an example below. The first chart is the value of Reliance Monthly Income Plan for a 3 month duration [Short Term view]. Second chart is a 5 year view of same scheme [Long Term]. Does that clarify what I am trying to point across ?
Reliance MIP – 3 month Chart – Source Moneycontrol.com
Reliance MIP – 5 year chart – Source Moneycontrol.com
Monthly Income Plans (MIP)
These instruments should not be confused with a post office MIP. I am specifically referring to MIPs offered by Mutual Fund houses. MIPs are a hybrid product which sits between a 100% debt instrument (like a FD) and an Equity, but more akin to a FD than an Equity instrument. Such MIPs invest a major part of their funds in fixed deposit type products which provide a steady income stream and growth. A minor part is invested into carefully selected Equity shares to provide an additional growth to the investors. The exact ratio between Debt and Equity varies from one scheme to another, with some schemes investing closer to 90% into debt and remaining in Equity, while others investing around 75% in debt and remaining in Equity.
Who Can Invest in MIPs
Since MIPs have an equity component, I would stay away from this product if my investment time horizon is less than 2-3 years. But if you are comfortable to park your money as long as bank FD for 3-5 years (preferably 5 years), MIPs can unlock their potential and provide a superior return than bank FD with a limited addition to your risk appetite.
FD returns can only go beyond a point. FDs can be compared as a man on a cycle riding at 20 km/hr speed . On the other extreme are real estate and equities which can be like a man in an aeroplane flying at 800 km/hr. In the middle are hybrid investments like MIP which perhaps can be classified as a Man on a scooter at 50 km/hr. The intention behind this comparison is to reflect that MIPs have a better potential to give you higher return than a FD without adding much risk to your plate if your invest duration is medium to long term.
Imagine if you are short of liquidity and need funds which are locked in your 5 year FDs, PPFs, NSCs, etc. What options do you think you have ? Perhaps only two – either liquidate them or take loan against FDs. If you liquidate, you will have to pay penal charge on premature liquidation of FDs. Lets take a contrast on MIPs. You can get them liquidated any day at the prevailing market value. If it is before 1 year from the date of investment, you will have to pay 1% exit charge.
Unfortunately FDs are the worse investment instrument when it comes to taxability. Any returns from your FD will be taxed based upon your tax slab. While this is a good news for people in zero tax slab, but the higher you earn, the lesser is post tax return from FDs as you may end up paying upto 30% on your FD returns. So even the best rated FDs will not give beyond 6 -7 % post tax return. MIPs are still better in this field if you sell them after 1 year from the date of investment. If you sell them before 1 year, they shall be taxed as per the FDs – your normal tax slab. However, if you sell them after 1 year, the gain on MIPs shall get classified as Long Term Capital Gain attracting 10% tax (without indexation) or 20% (with indexation) which ever is lower. So if your MIP has same return as a FD (say 9%) and you sell it after 1 year, your post tax return will be 8.1%, which is much better compared to FD’s post tax return (6.3%) !
To give more perspective, I would like to highlight the returns which MIPs have given in past 5 years (return calculation as of 15 March 2013 (source morningstar.co.in). I have selected a few good MIP plans in the markets and their returns over a period of 5 years and how much would your Rs. 10,000 become if you invested for 5 years. The behaviour of one MIP (Reliance MIP) over this duration of 5 years has already been reflected in the chart above to give you clarity as to the implicit volatility in such products.
|Scheme||Year 1 (%)||Year 3 (%)||Year 5 (%)||In 5 years, Rs. 10K becomes|
|DSP Black Rock MIP||
|Birla Sun Life MIP Saving||
So what do you feel after reading through this article ? Is MIP your cup of tea or would you give it a miss. Frankly speaking, if your investment time horizon is less than 3 years, please avoid MIPs as the equity element of MIP may give you a surprise (both negative & positive). However if you are having 3-5 years plus kind of time horizon, then MIPs may be a better suited product for you.
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