Mutual funds have become a popular investment option these days. Apart from choosing mutual funds for the long-term, investors are also opting for mutual funds to earn monthly income.
Here is a complete guide to help you understand how you can get monthly income by investing in mutual funds.
Meet Mutual Funds
Mutual funds collect money from several investors and all the money is then invested in a mutual fund scheme. They are managed by highly skilled professionals called fund managers.
The obvious question here is, how is this different from stock trading? Stock trading is when you buy individual stocks of different companies.
But mutual funds club the stocks of a couple of companies to maximize returns and reduce risk.
For example, you want to buy stocks for ₹10,000. Firstly, stock trading requires hours of research and months of tracking the data of a particular stock.
You do all your homework and buy the shares of ABC company. Let’s say, ABC company is an IT (Information Technology) firm and it provides its services to clients in Europe and the U.S.
One share of ABC costs ₹2000, and you have bought 5 shares. The problem here is that your profits will solely depend on the performance of ABC. If the value of the shares falls, the stock, which was worth ₹10,000 earlier, might be worth ₹8,000 later.
So, how do you remedy this? You take your ₹10,000 and invest across the stocks of several companies, which belong to different industries.
In this case, even if the value of one company’s share declines, the other company stocks will be performing well. So, the losses made by one stock will be adjusted by the profits made by the other stocks.
This is what mutual funds do. They take your money and invest across various companies’ stocks, debt instruments, commercial papers, and so on. This helps you to earn returns even during stock market crashes.
Now that you have understood what mutual funds are, there are a couple of ways in which you can earn monthly income from mutual funds. Here’s how you can do that.
Monthly Income Plans (MIPs)
A monthly income plan (MIP) is a type of mutual fund investment that primarily invests your money in debt and equity securities with a focus to create a regular stream of income for yourself.
MIPs come in growth and income options, with the growth options working like an equity fund. The growth option does not offer regular income.
However, the income option provides periodic dividend payouts. For example, let’s say you own 5,000 units of a mutual fund scheme and the fund declares a dividend of ₹2 per unit.
So, you will get ₹10,000 as a dividend in that scheme.
These mutual funds are actually debt or hybrid funds with an option of a monthly dividend payout.
Most of these funds are conservative in nature. These funds invest only 10-20% in equity while the remaining 80-90% are invested in safer debt instruments.
However, you can also choose the equity weightage of your MIP. The MIP Aggressive option invests up to 30% in equity investments and the MIP conservative invests up to 15% or less in equity portion.
Monthly income plans might not be able to give you very high returns due to their limited exposure to equity. However, they are a good instrument to offer inflation-beating income to investors.
These schemes are generally said to be an alternative to other fixed income-bearing instruments like Fixed Deposits (FDs), Public Provident Fund (PPF), etc.,
MIP mutual funds are better than fixed deposits when it comes to taxation. The income from fixed deposits is taxed every year despite you receiving money only at the time of maturity.
However, gains from MIP mutual funds are taxed only if you want to redeem your investment and not if you reinvest your earnings.
Short-term gains are added to the investor’s income and taxed according to the slab rate while long-term capital gains tax is at the rate of 20% with indexation and 10% without indexation.
Systematic Withdrawal Plan (SWP)
A Systematic Withdrawal Plan (SWP) is a facility that allows an investor to withdraw money from an existing mutual fund at predetermined intervals.
It helps investors to create a regular flow of income from their investments. You can withdraw your money monthly, quarterly half yearly, or annually on dates chosen by you. It ensures a regular cash flow for your income needs.
SWP is the exact opposite of the Systematic Investment Plan (SIP). In SIP, a fixed amount is transferred on a regular basis from your bank account to the mutual fund.
However, in SWP, the flow of transactions is reversed. The tool of SWP is helpful for investors who require regular cash flows to meet their expenses.
Suppose you have 10,000 units in a mutual fund scheme. Using SWP, you have asked the fund house to withdraw ₹5,000 every month.
On 1st January, the NAV of the scheme was ₹10. So, an equivalent number of MF units = ₹5,000/₹10 = 500. Hence, 500 units will be redeemed and ₹5,000 will be given to you. Now, you have 9,500 remaining units (10,000-500 = 9,500).
Next, on 1st February, the NAV is ₹15. Thus, an equivalent number of units = ₹5,000/₹15 = 333. Hence, 333 units would be redeemed from your mutual fund holdings, and ₹5,000 would be given to you.
Now, you have 9,167 remaining units (9500-333 = 9,167). This process will continue until the time you want the withdrawals.
When you choose the SWP, you can withdraw as much as you want from the fund since there is no upper limit on the amount you can withdraw.
However, you have to keep in mind the total corpus you have in the scheme and how long it can last. For example, suppose you have ₹50 lakh in a scheme, which offers a 7% average annual return.
In this case, you can choose a monthly SWP of ₹50,000, it will last for slightly over 12 years. But if you lower the SWP amount to ₹40,000, it will last you for more than 18 years.
In The End…
MIPs and SWPs are often seen as a perfect option for retirees who need regular cash flow for meeting day-to-day expenses.
This doesn’t mean that you should not opt for MIP or SWP if you are not a retiree. You can still choose these plans if you require an additional income to help you with the increasing living costs.
If you are looking to earn monthly income, mutual funds are the right investment option for you, and MIP or SWP is the right mode for you.
Head over to Koshex and start investing in mutual funds today to earn a regular income. Create an account with us in less than 3 minutes. No need to do lengthy paperwork as everything can be done online with no hassle. Sign up today.