SWP v/s Dividend: Which is the better option to invest in hybrid funds?

The popularity of hybrid funds, previously known as balanced funds, is going downhill nowadays.

Net inflows in hybrid funds in FY 2018-19 are likely to be the lowest in the last 4 years. On average, monthly inflows in hybrid funds have fallen nearly 88% on a Y-o-Y basis in FY 2019 at a time when the average monthly inflows in equity schemes have reduced by 37%.

Hybrid funds: Witnessing a massive erosion in inflows

Note: # Inflow only upto February 28, 2019, are considered

(Source: AMFI India)

It seems, FY 2016-17 and FY 2017-18 were exceptional years for hybrid funds. Post demonetisation, interest rates on FDs dwindled. In contrast, equity markets did exceptionally well after the initial knee-jerk reaction to discontinuation of high-value currency notes.

Vibrant market conditions allowed hybrid funds to declare dividends almost every month and sustain them until recently. Against interest of 6.5%-7.5% on FDs, the annual dividend yield of hybrid funds was in the range of 8%-12% and looked attractive to many investors.

Some fund houses as well as distributors aggressively marketed hybrid funds to novice investors. In effect, many investors, especially retired-category individuals, considered dividend as a reliable cash flow tool.

Are you one of them?

Do you depend on dividends declared by mutual funds to meet your household expenses?

If yes, it’s time to recalibrate your investment strategy.

Now that the going has gotten tougher in the markets, many fund houses are finding it challenging to pay regular dividends.

Myths busted…

First and foremost, mutual funds can declare dividends only out of their realised gains after factoring in unrealised losses. Hence, there’s no guarantee that mutual funds can sustain their dividend payouts in future. The dividend depends on the realised surplus available with the fund.

If you are getting a dividend yield of 8%-12%, that does not necessarily mean your total returns would be equal to or more than the dividend yield. It’s entirely possible that you are making modest capital losses. Don’t forget, whenever a fund announces a dividend, its Net Asset Value falls correspondingly.

How can you take control of your cash flow needs?

If you need regular cash flow and are convinced about investing in hybrid funds, it is better to opt for SWP (Systematic Withdrawal Plans). When you enrol for SWP, you give a mandate to a mutual fund to redeem a fixed amount every month. This way you control how much you withdraw from your holdings; it’s not left up to the fund house and SEBI rules.

Things to remember while registering for SWPs

Markets don’t move in a straight line. It’s possible that you might end a year lower than where you started, after factoring in your SWPs. Yet in the long run power of averages ensures SWP is a good deal for you.

Therefore, be conservative while you choose the SWP amount.

Consider the following example:

Manish held 29, 337 units of a hybrid fund on February 28, 2018, whose market value was Rs 7.50 lakhs.

He chose to withdraw Rs 5,000 through SWP every month—translating in a yield of 8%. Over the next 12 months, he withdrew Rs 60,000 and despite a reduction in the number of units to his credit, his total investments valued at Rs 7.93 lakhs as on February 28, 2019.

If you add up his withdrawals and capital gains, his total returns were 14%.

Start an SWP in hybrid funds…

(Note: For illustration purpose only)

Assume the market will have a few bad years in future; still, choosing an SWP amount conservatively will work in his favour.

As against this, if he depended on “so-called” dividend payments, he might have been disappointed on numerous occasions in the last 1 year.

Key takeaways for investors

Dividends aren’t dependable although they might look convenient to you. You should be in the driving seat always when it comes to your finances. A fund house or its fund managers will not have any idea about how badly you need a fixed sum every month; it is for you to decide.

Wake up! Start an SWP today if you need dependable cash flows from mutual fund investments.

If you are young and yet to accumulate a sufficient corpus for your retirement, the reverse of SWP, i.e. SIP (Systematic Investment Plan) is the place to be for you.

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PS PS: If you still haven’t made investments to save taxes this fiscal, here’re some last minute Tips to save Tax in FY 2018-19.