Over the last 18 months, an unusual trend has been observed. There has been a swift and steady outflow of capital from fixed deposits into balanced funds. Fixed deposit investors have always looked towards avenues that offer fixed returns and guaranty protection of capital. Balanced funds promise neither. So, how did they become an attractive alternative to the traditional fixed deposit?
A Miracle Solution
On the contrary, equity markets enjoy zero dividend distribution tax. Additionally, long-term capital gains (LTCG) are currently exempt from tax. While debt markets hit a rough patch, equity markets have been following a one-way trajectory…upwards.
Balanced funds have been pitched as a suitable alternative to fixed deposits because they also have a debt component. Banks aggressively sold these funds to clients. This is yet another instance where banks have prioritized their revenue interests over their clients’.
Balanced funds were a miracle solution – they were offering seemingly higher returns than FDs while supposedly being safe. In addition, they are more tax efficient and were even offering to pay regular monthly dividends. Unlike interest income, these dividends are tax-free.
More importantly, regular dividend payouts are not sustainable. In mutual funds, dividends are paid from booked profits in a scheme. Essentially, the fund houses sell securities to book profits and this is handed back to investors in the form of dividends. It’s important to note that if the markets correct, the dividend will be paid from invested capital.
Balanced funds have been touted as the ideal asset allocation fund. However, since a majority of the investment is in equity instruments, it can’t work as a “one-size fits all” solution. The more prudent choice would be to work towards asset allocation across debt and equity. For regular sustainable cash flows from mutual fund investments, a prudent Systematic Withdrawal Plan would make more sense.
At ithought, we have been working towards creating fixed-income solutions for our clients that are customized to their cash flow and return expectations. If you would like to explore our offerings, please get in touch with us.