Investing is very important if you want to achieve your goals and be financially independent. Traditionally, your parents opted for safer investment avenues such as fixed deposits (FDs), gold, and Public Provident Fund (PPF).
With rising inflation, meeting your goals such as children’s education and your retirement through these traditional routes is not possible. You need to find other investment products that deliver inflation-beating returns.
Equities are one such option; however, these are very risky and you may not want to jeopardise your capital investment. Asset management companies (AMCs) offer another option in the form of equity funds. These funds invest the corpus in the stock market to generate higher returns for investors like you.
The primary objective of equity mutual funds is to beat the returns given by fixed-income securities. Therefore, these funds are beneficial to create wealth in the long-term and achieve your financial objectives. However, there is an inherent risk because equity mutual fund returns are based on the market conditions and volatility.
Here is how you may invest in mutual funds without risking the loss of your capital.
Dividend transfer plan
With a dividend transfer plan, you may invest the dividend earned on a particular mutual fund scheme into another scheme offered by the same AMC. To do this, you may invest your capital in an arbitrage fund’s dividend option and then choose the dividend transfer plan. The dividend earned on the arbitrage fund must be invested in diversified equity funds. This enables you to invest in equity mutual funds without risking your capital’s loss. In this arrangement, if the stock market sees a big correction, only the dividends are at a risk while your capital remains secure in the arbitrage funds.
Let us now understand how this arrangement works.
Firstly, the arbitrage fund manager buys stock in the cash market and at the same time sells an equal quantity in the futures segment. There is no risk related to the stock market. The objective is to benefit from the price differential to generate returns on the arbitrage funds. Generally, arbitrage mutual fund returns are in line with the earnings in the money market.
Although arbitrage funds earn returns in line with bond funds, these are considered as equity schemes for the purpose of taxation. When these funds declare dividends, you may invest these in your chosen equity schemes. A dividend transfer plan in an arbitrage fund is beneficial because such schemes distribute most of the profits, as there is no dividend tax applicable on the same.
Before you opt for such investment plans, here are two factors you must consider.
- Amount of dividend
In case the dividend earned on your arbitrage fund investment does not meet a certain minimum threshold limit, the same is reinvested in the same fund. Most of the AMCs maintain the minimum threshold limit of INR 500. Therefore, the capital invested in the arbitrage fund must be able to earn at least INR 500 in dividends to opt for the transfer plan. To overcome this limitation, you may opt for investing quarterly or bi-annual dividends instead of monthly investment option.
- Minimum investment
The AMCs have a minimum investment limit for the transferee scheme chosen by you to invest the dividends earned on the arbitrage fund. You need to meet this limit unless the mutual fund house is willing to waive it. For most of the diversified equity mutual funds, this limit is INR 5000. If the initial dividend on the arbitrage fund does not meet this minimum investment norm, you may have to invest some part of your capital to overcome the shortfall.
The AMC will transfer the dividends if both the aforementioned conditions are met. However, you must remember that the frequency and amount of dividend are not guaranteed by the fund house. The returns are dependent on the arbitrage opportunities that are available in the market.
Investment plans must be based on in-depth research and analysis. This is a time-consuming and technical process. If you do not have the time or expertise, you may choose ARQ, our smart investment engine. As a core highlight of our Angel Wealth mobile application, it uses scientific methods such as algorithms and quants to analyse and evaluate different funds based on a billion data points. ARQ then provides customised recommendations depending on your financial objectives, risk appetite, and lifestyle. The entire procedure is automated with no human intervention ensuring there is no bias in the investment recommendations offered.
Download our mobile app and invest your capital in mutual funds that offer the lowest risks.