I am 67. Post-retirement, I worked for about four years and then stopped. I have been putting all my savings into bank deposits for safety, and because I do not have the knowledge, skill and time for other investments.

I have a pension of ₹40,000 and interest income of about ₹50,000 per month. My tax-free income from dividends (current value of investment about ₹10 lakh) is ₹10,000 and that from tax-free bonds is ₹50,000 a year (investment ₹5 lakh). I have no other liabilities or responsibilities.

My main worry now is income tax. With bank deposit rates falling, all my renewals will be at lower rates and my income will shrink substantially in the next two years. I am looking for safe investment where tax free dividend yield will be significantly higher than the yield on bank deposits and my capital is protected. My current investments in mutual funds are: ICICI Pru Tech Fund, ICICI Pru Multicap Fund and HDFC Large-Cap Fund. Please suggest 4-5 MF plans where I can invest on a regular basis.

Devdas

There is no mutual fund investment that can guarantee capital protection. Equity funds, a few of which you already own, carry a significant risk of capital losses. This is especially true at times such as now, when the stock market has delivered exceptional performance in the last three or five years and stock valuations are ruling at high levels.

If you are invested in the three equity funds you named, unaware of these risks, exit them now. This will help you lock into the gains you have already made in your portfolio and shield it from the possibility of losses in future.

While the dividends declared by equity funds are tax-free, you need to recognise that the dividends come only out of the NAV gains already earned by these schemes.

The dividend distribution in a mutual fund is essentially a return of a part of the NAV gains. Should the stock markets decline from these levels, the NAVs of the equity funds you own will certainly fall in tandem and they may skip dividend payouts.

MFs are allowed to distribute dividends only out of profits realised. So, you cannot count on the dividends from equity funds for regular income.

Debt mutual funds carry lower risk to capital than equity funds. But they do not guarantee zero risk of capital losses. In the case of gilt funds (funds that only invest in government securities), a rise in interest rates in the economy can lead to the fund’s NAV falling, resulting in a capital loss for the funds’ investors. (When interest rates rise, investors usually sell older bonds carrying lower interest rates).

In the case of debt funds that invest in a mix of G-Secs and corporate bonds (income funds, credit opportunities funds, short term income funds and liquid funds), companies whose bonds they hold can default on repayments. Such defaults can trigger a fall in the fund’s NAV. Therefore, if you are a completely risk-averse investor, you should stay away from mutual funds.

However, seeing that you earn about ₹90,000 a month from pension and interest income which can take care of living expenses, and have no specific liabilities, you can allocate a portion of your portfolio to arbitrage or liquid/money market funds to earn a more tax-efficient return. Arbitrage funds earn debt-like returns from trading on the cash futures arbitrage in the stock market. The gains on them after one year and dividends declared are both tax-free.

In the case of liquid/money market funds, investments are mainly in treasury bills and money market instruments. Dividends in these funds are declared after a dividend distribution tax of 28.8 per cent.

But if you opt for the Growth option and use a Systematic Withdrawal Plan (a standing instruction to redeem a specific amount every month) for regular income, your returns within three years will be taxed as short term capital gains and returns after three years will be taxed at 20 per cent with indexation benefit.

In both cases, the tax outgo will be lower than for your bank deposits, where interest is taxed at your income tax slab rate.

The suggestions in the arbitrage category are Edelweiss Arbitrage Fund, Reliance Arbitrage Advantage and ICICI Pru Equity Arbitrage. In the liquid category, go for ICICI Pru Money Market Fund, Quantum Liquid Fund and UTI Money Market Fund. You could switch the money currently invested in equity funds (₹10 lakh) to these products.

Send your queries to mf@thehindu.co.in

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