November 6, 2009
Annuity Mutual Funds vs Monthly Income Plans
An annuity mutual fund is a type of fund that focuses on income rather than growth. The income is distributed to investors on monthly or quarterly basis but these are usually referred to as monthly income plans.
Income funds are sometimes mistaken as debt funds. While a debt fund may invest only in bonds, government securities and corporate debt, an income fund may also hold stocks of blue chip dividend paying companies. An income fund that invests in stocks is more accurately known as equity income fund.
Generally, investors of annuity funds are more interested in a regular income rather than growth. Annuity funds are an excellent tool for retired people and also for people wanting to balance their portfolio.
Income funds are generally risk free but there are two types of debt funds that carry a high risk. These are those that invest in ‘junk’ bonds of companies and floating rate loans of banks and other financial institutions.
There are instruments in the money market that are safe for parking money. These generally give returns that are substantially higher than interest rates of savings accounts or fixed deposit certificates of banks and corporate houses. These money market instruments are available only to large institutions or high net worth individuals. An annuity mutual fund provides an opportunity to the small investor to park funds in these instruments.
The preferred choices of annuity mutual funds is to invest in a variety of investment grade debt obligations of governments and municipal corporations and top quality corporate debt and shares of companies with a long history of handsome and uninterrupted dividend payouts.
The value of a debt fund is not fixed and tends to fall after every payout. If the income fund is listed on the stock exchange the price of an annuity fund moves inversely to interest rates. When interest rates are rising, the price of an income fund takes a hit and increases when interest rates are falling.
Annuity mutual funds derive their income from three sources:
- Income from bonds (interest) and equity dividend.
- Realization of capital gain if the price of securities held by the fund goes up.
- Selling the entire basket of securities at a profit.
In the first two cases the income yield reflects in the monthly/quarterly payout to investors. The third option is exercised when the fund is terminated, which may sometimes amount to booking a loss. The investor is offered two options when the fund is terminated: either to receive the redemption amount or invest in a new scheme.
Most investment companies have a waiver clause on intercompany switch over. Investors willing to continue with mutual fund investments are well advised, to the extent possible, to choose a new scheme of the same investment company to take advantage of the waiver.
Although, a typical income debt fund offers monthly payouts, investors wanting only the safety of their capital without a regular payout can choose a reinvestment option offered by many income funds. Since the periodic payout is reinvested it is tantamount to the growth option of mutual funds.