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Do not rely on equity funds for regular payment of dividends

There are two main ways in which an investor can make regular monthly income using mutual funds

I have received a bonus of 1 lakh. I would like to invest this money into mutual funds for around six months. Which schemes should I invest in?

—Rahul Mishra

A short investment time frame of six months significantly reduces the options available for a mutual fund investor. Schemes with any amount of equity market exposure should be considered off the table since the risks associated with stock market investing cannot be mitigated by such a short time, regardless of the diversification benefits offered by such funds. Even among debt funds, those that invest in instruments with a longer duration would be considered risky since they are not immune to capital loss in this time frame.

Considering these factors, the only types of funds you can invest in are liquid funds and ultra short-term funds that are the least risky types of debt funds. Even among these funds, check the details to ensure that they do not have any exit load penalty for withdrawals at or before six months. Most such funds do not, but it would be prudent to verify before investing.

I have put money in a fixed deposit and have a life insurance plan. What is the best investment option among mutual funds to get a regular monthly income?

—Deepa Menon

There are two main ways in which an investor can make regular monthly income using mutual funds. One is to go for funds that have a monthly dividend option, and the second is to go with the systematic withdrawal plan (SWP).

The advantage of the dividend approach is that you will continue to hold the units in your folio, but the downside is that the amount of income (in the form of dividend) would vary from month to month depending on the distribution from the scheme. With SWP, you will know exactly how much you will get as income every month, but that would mean redeeming units from your folio. So, if you are keen on getting a fixed monthly amount as income, you should go for the SWP option, but if you are comfortable with variations in the income (and can supplement for shortfalls from other sources), you could stay with the monthly dividend payout option. Additionally, do note that equity funds cannot be relied upon to pay regular dividends.

Taxation is another important factor to consider. If your mutual fund investments are old enough to be tax-exempt (in the case of equity funds) or tax-favoured (in the case of other funds), then you can consider SWP since they involve redemption of units. If the mutual fund investments are of recent vintage, then dividend payout would be a better option since dividends are tax-free in the hands of the investor. Also, if you are in a lower income tax bracket (10% or 20%), SWP would be the better option to go with since dividends are subject to dividend distribution tax (of 28.33%) prior to distribution.

Queries and views at mintmoney@livemint.com

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