I am a long-term high-risk investor with SIPs in Aditya Birla ELSS, SBI Blue Chip and SBI Small Cap funds. After going through recent data that about 50% of actively managed large-cap funds have failed to beat the index, I am looking at buying SIPs in exchange-traded funds (ETFs) and index funds for 4-5 years. Can you suggest one or two high-performing ETFs and index funds?

—K. Routray

It is true that large-cap funds, on an average, have struggled to beat their benchmark indices for the recent one-year period. As I write this, the Nifty 50 index has outperformed the average large-cap funds’ returns by 1.3% in the last one year (point-to-point returns). However, if you look at even slightly longer term returns, you will find actively managed funds, on an average, doing better than the indices, with better managed funds (above-average funds) doing significantly better. For the last 3-, 5-, and 10-year periods, actively managed funds have outdone the benchmark index by 1.2-2%. Of course, one could make the argument that the extra fund management risk assumed by investing in an actively managed fund is not commensurate with this margin of out-performance. It is a judgement call that investors and advisors across the country are taking differently depending on their outlook of the market.

All said and done, going for passive index funds and ETFs for this segment of funds in one’s portfolio is not a bad idea at all. You could consider one or both of two funds in this regard—the UTI Nifty Index fund will mimic the Nifty 50 index at a low cost, and the ICICI Prudential Nifty Next 50 index fund will invest in the Next 50 index that invests in companies 50-100 in the Nifty list of stocks. Between these two funds, you’ll have a broad coverage of the entire large-cap segment of the market at a low cost and without incurring any fund management risk. However, I would still advise you to stick to actively managed funds for other parts of your portfolio such as small- and mid-cap funds and diversified funds.

What are the benefits of a systematic withdrawal plan (SWP)? How does it work and what are the tax consequences?

—Sai Prasanth T

SWP is the other side of the coin with respect to the more popular SIPs. While SIP allows you to invest in pre-determined instalments in an automatic manner, SWP allows you to withdraw fixed amounts in a pre-scheduled manner. In my opinion, this is the best way to use mutual fund investments for supporting regular cash flow (expense) needs, and it is much better than using the dividend method. With dividends, both the amount and the frequency are unpredictable (especially with equity-oriented funds), and now they are also subject to taxes being withheld by the companies. When it comes to SWP, it is not subject to any of these limitations—an investor specifies how much money they need and at what frequency, and the money is withdrawn from their investment and paid out to them. Both the amount and the frequency are preset and not subject to any vagaries. Moreover, when it comes to taxation, since withdrawal from an MF investment is always part principal and part profits, the amount of taxation will likely be less than for dividends. Only the profit part of the withdrawals will be subject to taxation and if it happens to be a long-term withdrawal (which the investor can control), it will be subject to a lower rate of tax or benefit from indexation adjustments. So, any which way you look at it—be it regularity, predictabiliy, or taxation—SWP scores over dividend method of deriving income from mutual fund investments and would be the ideal way to generate regular cash flow.

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Srikanth Meenakshi is co-founder and chief operating officer, FundsIndia.com.

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