Which category of MF is ideal, if I am looking for a regular cash flow?

Investors who seek monthly fixed returns opt for monthly dividend distribution schemes. However, dividend distribution in balanced fund schemes does not guarantee monthly dividends. Hybrid mutual funds offer balanced fund schemes. Balanced funds have a hybrid asset allocation wherein 65% of the investment is in equity and the remaining 35% is in debt instruments. During market lows, the net asset value (NAV) of the scheme can go down and lead to lower reserves and ultimately little to no dividend distribution. The cash inflow and gains in the form of dividends are not exempt from tax. 10% tax will be levied on dividend distribution called the dividend distribution tax (DDT) and 10% on long-term capital gains. If investors are looking for regular cash flow from mutual funds, then they should opt for Systematic Withdrawal Plans (SWPs).

Systematic Withdrawal Plan

When an investor redeems the units from a mutual fund scheme, a predetermined sum of money is credited to the investor's bank account on a specific date. This is called the systematic withdrawal plan. Although SWP may not be as popular as SIP, the former is beneficial in the distribution phase. While dividend distribution leads to the fall of the net asset value of the scheme, in the case of the systematic withdrawal plan, there is a fall in the number of units of the scheme. Investors who seek regular cash flow can make investments in a liquid fund and then opt for the systematic withdrawal plan. This way, the effect of market volatility on the capital decreases. It also reduces the impact of the market volatility on cash flow from the mutual fund. SWP guarantees fixed monthly returns even during market lows and if the scheme does not perform well, and even if the fund house has to dip into the principal to make the payout. Also, when it comes to SWP, lumpsum/higher investments will ensure the capital is not eroded quickly.

Is dividend plan good for cash flow?

Declaration of dividend is dependent on the fund house. Some may choose to declare dividend on an annual basis which may not be consistent as it is based on their earnings. Therefore, depending on dividend plans for regular cash flow may not be an ideal choice. In a rising market scenario, regular dividend strategy works. Whereas in a falling market, it is better to choose a debt option, at least in the initial years. In the case of a balanced fund, the investor can wait for a few years before taking money out.

Short-term and long-term capital gain tax

If an investor redeems the units of a debt fund/scheme before the completion of 3 years from the unit allotment date, then short-term capital gain tax is applicable on the profit. Likewise, if the units are redeemed from an equity scheme before the completion of one year from the unit allotment date, then long-term capital gain tax is levied. That said, while investors can choose to invest in fixed instruments such as fixed deposits (FDs) and tax-free bonds, the interest distribution is usually set at half-yearly or annual intervals. Whereas in an SWP, the frequency of distribution is determined by the investors which gives them an advantage over the above-mentioned fixed instruments. Moreover, short-term capital gain tax will not be applicable if the investor chooses SWP post one year of investing.

In conclusion, investors who seek regular income or cash flow from mutual funds should invest their money in a debt fund and then make systematic withdrawal plans in order to get a monthly income. Debt funds have tax advantage over fixed deposits as the latter is fully taxable while the gains from the former is only a part of the redemption proceeds. A major portion of the redemption proceeds happens to be the principal which is not taxable. Furthermore, after completion of 3 years from the date of investment, the gains from debt funds are treated as long-term capital gains which are taxed at a lower rate (20%). Note - It is advisable to consult a mutual fund manager/expert to find out which fund best suits your investment needs.