Mutual Funds are traditionally classified on the basis of the asset class they invest in. The ones which invest only in stocks are called equity funds and the ones that invest in bond or other debt instruments are called fixed income or debt funds. The funds which own both stocks and bonds are called Equity Hybrid Funds.
Equity Hybrid Funds were earlier known as balanced fund. You can read what are balanced funds
As Equity Hybrid Funds are exposed to both equity and debt, it helps those investors who want an all-encompassing fund for their investment purposes. These Funds tend to have 65-75% exposure to equities and the rest 25-35% to debt instruments. While the equity component makes the fund capable of beating inflation and gives good returns over a long investment time horizon, the debt portion of the portfolio provides stability and gives consistent returns.
Another important advantage of Equity Hybrid Funds is that the dividend paid by them is tax free in the hands of the investor. Equity Hybrid Funds are taxed as equity funds and the long term capital gains (LTCG) is tax free upto Rs 1 Lakh in a year. Long term capital gains beyond Rs 1 Lakh are taxed at 10% only.
In case of Mutual Funds, dividends are paid out of distributable surplus / or the profit made by the fund. This is why the dividends in mutual funds are neither fixed nor assured.
In such a scenario it would mean that the investors cannot get a regular return from their investments. Then, what is the way to get a regular return from your investments? There is a simple and smart solution to this which helps mutual fund investors who have regular cash flow requirement. It is called Systematic Withdrawal Plan or SWP. Let us find out how this works -
In a SWP, one can withdraw a fixed amount of money regularly from their investment in Mutual Fund scheme/s. The frequency and amount for this is decided upon by the investor and it can be monthly, quarterly or annually. It generates fixed cash flow for the investors by redeeming a certain number of units that matches the redemption value at the current NAV. Thus, the unit balance of the investment reduces and the rest of the units continue to accrue returns over a long tenure.
Let us now see a live example –
Investor 'A' invested Rs 10 Lakhs in SBI Equity Hybrid Fund 10 years back. He started withdrawing Rs 7,500 per month (annual 9%) through SWP after one year from the date of investment just to avoid short term capital gains tax as well as the exit load.
In the last 9 years, Investor 'A' has withdrawn Rs 8.10 Lakhs in total but still the fund value has grown to over Rs 30 Lakhs. Effectively, the fund has grown 3 times despite regular monthly SWP withdrawal.
Please see the result of the above SWP example -
The investor can get benefits of both capital appreciation as well as regular income if the withdrawal rate per annum is lesser than the long term annualized return of the fund. Investors must note that results of SWP are best reflected over a long time period, as you can see in the above example.
Let us now discuss why Equity Hybrid Funds are best suited for SWPs -
When the market is bearish, MF investments decline in value due to a fall in the Net Asset Value (NAV). This affects SWP too as with lesser NAV value, more number of units would have to be redeemed from the scheme for meeting investor’s cash flow requirement. If the fund is volatile, then in a bearish market, it can lead to substantial unit depletion. But, in case of Equity Hybrid Funds, downside risks are limited by asset allocation. It is obvious that in a bear market the NAV of Equity Hybrid Funds may decline too but what we need to understand here is that the drop will not be as sharp as in the case of equity mutual funds as a good percentage of the portfolio is invested in debt instruments. The investment, thus, will recover in its value faster when bull market commences again.
In this article or while showing the SWP example, we have not taken into account the impact of exit load and tax while explaining the concept of SWP but the investors must take into account these factors. Ideally SWP Withdrawals should begin after exit load and short term capital gains tax period (which is now currently one year). Also, during the initial years, the annual SWP withdrawal percentage should not be more than 9-10%, if you are investing in an Equity Hybrid Fund to start SWP.
We explained in this article how SWP option from Equity Hybrid Funds can be a good, simple and hassle free option for investors to gain regular monthly income. You can contact us to plan your regular cash flow requirement using the systematic withdrawal plan route.